There Is No Inflation: The June CPI Headline Head Fake

WASHINGTON, DC – MAY 26: U.S. Senator Ron Johnson (R-WI) talks at a press conference on Capitol Hill on May 26, 2021 in Washington, DC, on… [+] inflation. Senators from both parties debated growing consumer costs and the impact of inflation on families and companies recovering from the pandemic. (Photo courtesy of Getty Images/Drew Angerer)
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Recent Breaking News: In June, “headline inflation” was… 5.4 percent. So says the Bureau of Labor Statistics. Wow. Some politicians and much of the media have reacted to the study with orchestrated astonishment and dismay, with write-ups that make it sound like the country has time-traveled back to the 1970s.
Or maybe not. Many individuals are now aware that the main figure – the raw Consumer Price Index (CPI) – is skewed. They may not realize how warped they are. Several factors are currently inflating its value – yes, “inflation” is inflating – to the point where the raw CPI is worthless, if not misleading.
A previous column went through the specifics. In summary, if these distortions were removed, the headline number for June would look like this.
For good reason, serious forecasters almost always rule out volatile food and energy prices. In June, the “Core CPI” was 0.9 percent lower than the headline figure.

Author’s Headline vs. Core Chart
ADDITIONAL INFORMATION FOR YOU
Continuation question: The unadjusted CPI has a variability of nearly 7 times that of the Core CPI. Everyone understands that in order to acquire a fair perspective on short-term price swings, this volatility must be balanced. Why, therefore, is the headline number still the raw CPI?
The Federal Reserve has chosen the Commerce Department’s Personal Consumption Expenditure Index (PCE) above the Labor Department’s CPI for the past 20 years, and with good reason. The PCE has undergone comprehensive testing. It is founded on a more sound understanding of economic behavior. It’s just a better metric.
“The PCE index is preferred by the Fed since it is a better picture of reality and how people consume.”

We haven’t yet received June’s PCE. It’ll be another two weeks before it arrives. We do, however, have a pattern from the past. Over the last 20 years, the PCE has averaged around 0.3 percent lower.

Author’s chart of CPI vs. PCE from 2001 to 2021
Another question: Why does the press focus on a group that policymakers mainly overlook?
The CPI is a comparison of the June 2021 and June 2020 numbers. However, the country was still in the grip of the pandemic in June 2020. We had just finished the second quarter with an annualized GDP decrease of 8.5 percent.

Author’s graph of annualized GDP growth from 2016 through 2021

Because the left-hand anchor of the year-over-year % calculation is so profoundly depressed, this broke the trend line, which throws off later comparisons for a while. The so-called base effect inflates the current year-over-year percentage increase (i.e., the CPI!) by around 0.9 percent for the month of June 2021.

Author’s Base Effect Diagram
Question: Even some journalists are aware of the problem (lately). The base impact will last for a few more months. So, given that the CPI is currently significantly wrong, why not wait until this statistical issue “clears” the system before making any more year-over-year comparisons? Because of the pandemic, we’ve had to make a lot of changes. Why not give it a shot?
The CPI is made up of a “basket” of products and services that consumers buy on a regular basis, or “goods and services that individuals buy for day-to-day living,” as the Bureau of Labor Statistics defines it.
Used vehicles are one of the items in the consumer’s basket. The price of a used car climbed by 45.2 percent from June 2020 to June 2021! This item has a 3.166 percent weighted in the “basket” of the consumer, which indicates it contributed about 1.5 percent to the whole basket’s year-over-year increase (i.e., the raw CPI). The BLS concedes that the used car component accounts for “more than a third” of the June CPI number.
There are numerous flaws in this. In summation, it is possible to argue that secondhand vehicles, like houses, are assets with a long life (more than 10 years and over 200,000 miles on average today — and that lifespan is growing). Used automobiles should not be included in the CPI if they are a long-lived asset rather than a throwaway product like a box of corn flakes that is purchased and eaten.
In any case, used cars hardly fit the description of an item “that people buy for day-to-day living” – should big ticket items, purchased only very rarely and usually involving a great deal of discretion as to timing and substitution opportunities – you may have to buy gasoline today to get to work, but you usually don’t have to buy that used BMW this week if the price isn’t right.
In 2020, the used car market was one of the most severely impacted sectors of the economy; there have been disruptions in the automotive markets in general, affecting new cars (chip shortages), used cars, rental cars, auto insurance… the entire eco-system has been thrown out of whack; it makes no sense to regard the current price gyrations as a normal pattern.

The controversy over whether or not secondhand vehicles should be included in the CPI calculation has raged for decades. Even the Congressional Budget Office, in 1995, chose to omit Used Cars, along with food and energy, from its CPI calculations. (I’ll go over this example in more detail in a future column.)
Other distortions can be found in the June number, particularly in energy pricing and a few other categories that were badly suppressed during the pandemic and are now rebounding with strong component-level base effects. Air fares (0.7 percent weighting in the basket), which are up 24.6 percent year over year, Hotel rooms (0.86 percent weighting), which are up 16.9%, and Car Rental costs (0.185 percent weighting), which are up 87.7%.

All of these industries were completely destroyed by the epidemic in the second quarter of 2020. Hotel occupancy rates have dropped from 61% to 24%. The number of passenger miles flown by airlines has decreased by 96%. Now is the time to dismiss these serious dislocations. According to my calculations, they contribute around 0.4 percent to the June CPI.
If you’re keeping track, we’re down to just under 2% for the adjusted price increase in June 2021 over June 2020 after these deductions.
Perhaps some of these tweaks could be fine-tuned even more. Perhaps there is room for counter-arguments. But my argument is that the headline statistic is significantly exaggerated by any sensible definition of genuine inflation.
There’s one more thing. When the garbage truck rumbles by in the middle of the night, the monthly inflation fear headline is like that car alarm that keeps going off. It’s inconvenient, but we know we don’t have to dial 911 every time the alarm goes off. Why do we let the inflation alarm rattle us in this way every month, oblivious to the bigger picture?
We are fortunate that the Fed, as well as the markets, can assess these figures with proper skepticism. However, there is a lot of poor reporting here. The above-mentioned distorting variables are not concealed, and most journalists are aware of them. Nonetheless, many in the media, as well as many professional pundits (who should know better), continue to stress these erroneous data. Isn’t it the press’s responsibility to educate the public? Is it simply a matter of selling more newspapers or grabbing more clicks?/nRead More