A Dozen Contrarian Thoughts About Inflation

According to the Bureau of Labor Statistics (BLS), there was a 3% increase in the Consumer Price Index (CPI) in June compared to the previous year. This represents a significant shift in the CPI, which had previously fluctuated between 0-2% in the past decade. The chart displayed above illustrates how the CPI rose to a peak of 9% before declining back to its current level of 3%.

In the previous year, I extensively discussed inflation in my writings—unveiling common misconceptions, highlighting the delayed response of the FOMC, and shedding light on the true origins of inflation, whether they are real, speculative, or theoretical.

After delving into the vast pool of research on space, I have come across various insights regarding inflation that differ from the popular consensus. Consequently, I have compiled a list of twelve notions about inflation that can be considered unconventional or contrary to the prevailing beliefs.

Inflation reached its highest point in June of 2022. After reaching new heights twelve months ago, it has been declining swiftly ever since.

I have been sharing my thoughts on this topic since June 2022. Initially, my viewpoint went against the popular opinion, but following the release of the CPI reports in May and June, more people are starting to embrace this idea (Traders caught on around October 2022).

2. "Lengthy and Inconsistent Delays?": The rate increases by the FOMC and other actions taken by the Fed eventually have an impact on the overall economy. However, there is ongoing discussion about the specific duration it takes for these effects to materialize. Economists who gained expertise in the 1970s/80s appear to be strongly attached to an outdated framework.

During the 1970s, when there was a continuous rise in prices and housing loan interest rates were in the double digits, it was reasonable to believe that it could have taken up to 18 months for the effects of FOMC (Federal Open Market Committee) policy to be noticeable. This was particularly true because the Federal Reserve was not transparent at that time, as they did not disclose information about rate changes, leaving people to deduce it from the bond market. Before 1994, the central bank did not issue a formal statement on their policies or engage in press conferences.

However, at present, that time period of 18 months appears to be quite lengthy.

In today's world, credit plays a crucial role in driving the economy forward, and the Federal Reserve has been quite open about its intentions, clearly communicating its plans to the market. This transparency is expected to minimize the time gap between the Fed's actions and the resulting impact on the overall economy.

3. Does Labor Lead to Inflation or Deflation?: The primary driver behind salary increases has been the scarcity of employees in multiple sectors; what we truly require is a greater workforce. I struggle to comprehend how elevated rates could contribute to this objective.

Salaries in the lower portion of the workforce have fallen behind key indicators such as Productivity, CPI, Corporate earnings, etc., during the last 30 years, causing deflationary effects. However, due to the prevailing shortage of labor in the United States, even individuals with the lowest wages are now receiving salary increases, which the FOMC perceives as contributing to inflation.

Economists such as Lawrence Summers are still trapped in an outdated way of thinking reminiscent of the 1970s. Summers' assertion that the sole solution to tackle inflation was to lay off 5 million individuals not only proved to be erroneous but also relied on an embarrassingly obsolete approach (not to mention the unnecessary cruelty involved). Thankfully, not many paid heed to his advice, and even better, he is not the Federal Reserve chairman, preventing a catastrophic recession brought upon by his misguided perspective.

4. Temporary didn't go as planned; it simply needed more time than anticipated.

A pandemic that occurs once in a hundred years, along with a worldwide lockdown that has never been seen before, took a significantly longer time to resolve than anticipated. There was absolutely no contemporary reference or similar situation to rely on, so everyone was compelled to speculate.

However, the fact that it took 27 months instead of the expected 12-18 months is not as much of a failure as some people perceive it to be.

5. Flaws Abound in Inflation Models. PCE, CPI, and practically all inflation models I monitor are imprecise yet valuable. The ones that exhibit consistency can serve as a foundation for studying the past. Nevertheless, depending on them to make immediate policy choices poses significant challenges.

They are falling behind, they make presumptions that may cause distorted outcomes, and they believe the world is less intricate than it truly is. They depend on past information, which can result in unreliable outcomes when new situations come up (just like in the current scenario).

Any company that does not grasp this concept is in danger of committing significant errors when it comes to decision-making and establishing policies.

6. Inflation Anticipation Surveys are Silly: They are incorrect. And unintelligent. And essentially pointless. Cease depending on them…

The Federal Reserve is pushing up home prices: three factors have decreased the availability of single-family homes, thus causing a rise in real estate prices.

A) Significant decline in new home building after the Global Financial Crisis; B) Home buying during the pandemic with no corresponding sale of previous homes; C) Over 61% of existing mortgages are subject to an interest rate lower than 4.0%. These affordable rates keep homeowners stuck as they cannot afford the higher interest rates of 7.5% or more for a new mortgage on a different home.

This all leads to a significant deficit in the number of houses that are accessible for purchase. We are unable to modify the actions of builders during the period of 2007-2020, nor can we influence the behavior of buyers from 2020-22. However, the excessively high mortgage rates are causing potential sellers to hesitate. The situation is exacerbated by the increase in rates.

The Federal Reserve is pushing up the OER: Due to the limited availability of housing, the sudden surge in interest rates has unexpectedly led to an increase in inflation instead of a decrease. This is particularly evident in the OER section of the Consumer Price Index (CPI).

For almost twenty years, I have been strongly criticizing OER. I am optimistic that this aspect of the BLS model will be refreshed in the near future.

Please note: During the mid-2000s, a time when there were plenty of houses available and obtaining credit was easy, open educational resources (OER) had the unintended effect of reducing the consumer price index (CPI) and making inflation appear less severe than it actually was.

9. To combat inflation effectively, we should adopt lower interest rates. The primary factors contributing to the current inflation are the escalating expenses associated with renting apartments, the scarcity of available homes, and a scarcity of workers. Instead of increasing interest rates, which could potentially exacerbate these problems, alternative solutions should be explored.

Increasing interest rates by the FOMC from their current levels has several negative impacts. Not only does it make the owners' equivalent rent (OER) appear more unfavorable, but it also diminishes the availability of single-family houses, leading to increased property prices. Additionally, this policy shift compels a greater number of individuals to seek rental accommodations, thereby driving up the cost of apartment rentals.

10. Both Individuals and Businesses Contributed to Inflation: Indeed, individuals are negatively impacted by inflation, but they also play a part in driving it by willingly purchasing goods and services despite price hikes. This holds true for essential items like food, energy, and clothing, as well as for non-essential items such as travel and second homes. Luxury goods like watches, sports cars, bags, and jewelry also contribute significantly to inflation. The increased demand for goods during the pandemic resulted in goods inflation, while the heightened demand for services after reopening led to services inflation. Subsequent to each of these surges, different types of inflation were observed.

Corporations capitalized on the disorder to enforce increased costs whenever possible. I initially had a different viewpoint, but I eventually changed my perspective.

11. Abandon the 2% Inflation Objective: Seriously. Following the Global Financial Crisis, the economy was sluggish and the Zero Interest Rate Policy/Quantitative Easing had pushed rates close to zero, making a 2% target seem reasonable. However, considering the significant fiscal stimulus of $5 or 6 trillion and mortgage rates reaching 7.5%, aiming for 3% or even 2.5% as a minimum inflation objective appears much more logical.

12. The Federal Reserve has triumphant ly achieved its goal: Success has been attained! Jerome Powell can now take a well-deserved break during the summer, indulge in fishing activities at Jackson Hole, and genuinely relax for the remainder of the year. There is absolutely no necessity for any additional rate hikes as the victory has already been secured.

To be honest, the Federal Reserve was slow in raising interest rates, slow in acknowledging inflation, slow in taking action, and they are currently slow in recognizing the significant decrease in inflation. However, even someone with limited abilities can stumble upon success occasionally, and they should accept this victory and refrain from making further decisions.

They are in danger of losing just when they are about to win.

Previous Post: The Futility of Predicting Inflation (May 17, 2023)

Misconceptions by the Federal Reserve

What's Causing Inflation: Workforce or Investment? (November 7, 2022)

How the Federal Reserve Triggers (Simulates) Inflation (October 25, 2022)

Why Does the Federal Reserve Always Miss the Mark? (October 7, 2022)

Progress is happening more slowly than anticipated for something that is meant to be temporary. (February 10, 2022)

Who Can Be Held Responsible for Rising Prices, 1-15 (June 28th, 2022)

Deflation, Interrupted by Occasional Bursts of Inflation (June 11, 2021)

The Lack of Knowledge Among Models (May 6, 2020)

My Honest Admission about Believing in Inflation (July 21, 2014)