Here's a bold statement: Inflation isn't as straightforward as it seems, and we might be missing the real story. Governor Miran's speech on the inflation outlook reveals a complex web of factors influencing price movements, challenging conventional wisdom. But here's where it gets controversial: Are tariffs really the main driver of goods inflation, or is something else at play? Let's dive into the details and uncover the truth behind the numbers.
Inflation, a topic that affects every household, is often misunderstood. Governor Miran starts by addressing shelter inflation, a significant component of inflation indices. However, calculating it accurately is far from simple. The Personal Consumption Expenditures (PCE) price index, which the Fed targets, includes housing costs for all households, but this might not accurately reflect current supply and demand pressures. As the economy recovered from the pandemic, housing demand surged, causing market rents to skyrocket. Yet, the PCE shelter index lagged, as rents only adjust when leases are renewed or people move. This lag creates uncertainty about the future of shelter inflation.
The Shelter Inflation Catch-Up
Recent data shows that a separate all-tenant rent index, drawn from the same microdata as PCE shelter, has caught up to new-tenant rents, while PCE shelter has overshot. This catch-up suggests that PCE shelter inflation will decline faster than expected. The current elevated readings are an echo of past supply-demand imbalances, not a reflection of the present. Factors like negative population growth due to net migration reversal and a historically mean-reverting ratio of shelter services consumption to overall consumption further support this view.
Core Nonhousing Services Inflation: A Different Story
Moving on to core nonhousing services inflation, which includes expenses like childcare, education, and medical services, we find a different narrative. This category has been relatively stable, hovering around the average level observed from 2002 to 2007, a period when core PCE inflation averaged 2%. However, not all components of this index are measured through direct transactions. Many services are imputed, which can obscure supply-demand imbalances crucial for monetary policy.
The Phantom Inflation of Portfolio Management Fees
A prime example is portfolio management services, which contributed significantly to core PCE inflation last year. The Bureau of Economic Analysis measures these costs based on asset managers' revenues, which are tied to assets under management. This method records increased revenues as higher prices, even though it should reflect increased service consumption. This statistical quirk has led to a roughly 20% increase in recorded portfolio management fees, contributing about 30 basis points to core PCE inflation. In reality, industry data shows a 6% decline in fees, indicating trend deflation.
Core Goods Inflation: Tariffs or Something Else?
Now, let's tackle the controversial topic of core goods inflation. The dominant narrative blames U.S. tariff policy for the recent rise. However, Governor Miran presents a compelling counterargument. The timing of the increase in core goods PCE doesn't align perfectly with tariff imposition. Moreover, the Consumer Price Index (CPI) shows an upturn in the middle of 2024, and while the Fed doesn't target CPI, it provides valuable insights.
The Incidence of Tariffs: Who Bears the Burden?
When analyzing tariffs' impact, we must consider the concept of incidence – who bears the burden of the policy. The U.S., as an importer, is relatively more elastic, meaning it can substitute demand across borders or manufacture goods domestically. In contrast, producers' factories and labor are less flexible. Studies by Anson Soderbery and others suggest that exporters bear a significant portion of the tariff incidence, especially for goods with high import value.
The Counterfactual: What If Tariffs Weren't the Cause?
Governor Miran presents alternative explanations for the rise in goods inflation. One possibility is that it's just noise in a volatile series. Another is that we're still experiencing post-pandemic oscillations around a lower mean level of core goods inflation. A third, less appealing possibility is that goods inflation is settling at a higher level due to long-term trends like trade restructuring and supply chain resilience concerns.
Policy Implications: Navigating Uncertainty
Given the uncertainty surrounding goods inflation, what should monetary policy do? Governor Miran argues that shelter inflation, which is more predictable due to market rents leading measured inflation, will likely counterbalance any sustained higher goods inflation. Core goods represent only 25% of the core PCE index. The real risk lies in shelter inflation picking up again or core goods inflation remaining well above 2%.
Measuring Underlying Inflation: A New Approach
To better understand underlying inflationary pressures, Governor Miran proposes a new measure that excludes distortions from shelter and imputed prices. This market-based core inflation, excluding housing, is running below 2.3%, within reach of the target. This approach, while potentially accused of cherry-picking, is more transparent and excludes less of the index than other measures.
The Human Cost of Tight Policy
Keeping policy tight due to past imbalances or statistical artifacts could lead to job losses. While American families are still reeling from the post-pandemic inflation surge, prices are now stable, albeit at higher levels. Policy should reflect this new reality.
Final Thoughts: Embracing Uncertainty for Better Decisions
In conclusion, Governor Miran's speech highlights the importance of acknowledging uncertainty in economic policymaking. By shedding hubris and embracing a clearer understanding of dynamics, we can make better decisions. As former Bank of England Governor Mervyn King and economist John Kay urged, pretending to have more knowledge than possible will only hinder our grasp of reality.
So, what's your take? Are tariffs the primary driver of goods inflation, or is there more to the story? Do you agree with Governor Miran's proposed measure of underlying inflation? Share your thoughts and let's engage in a thoughtful discussion, avoiding the pitfalls of groupthink and embracing the complexity of economic reality.
