Monday, February 19, 2018

PCE Inflation

I usually update CPI inflation, since it is updated monthly.  Detailed PCE inflation is only updated quarterly, so I haven't tended to review it as often.  But, I thought it was worth checking up on.

Here is PCE (personal consumption expenditures) inflation through the end of 2017.  It follows a similar pattern as CPI inflation.  PCE core inflation is about 1.5%.  But, this consists of housing inflation above 3% and non-housing inflation of about 1%.*

It's always worth a reminder that Taylor Rule based complaints about monetary policy in the 2000s have to ignore the fact that PCE inflation never strayed far from 2%, and that non-housing core PCE inflation was below 2% for the entire period.  It is stunning to think that we live in a regime that has both (1) a central bank that explicitly runs an inflation targeting program and (2) a large contingent of economists who claim that for several years, a fundamental feature of the economy was a central bank that held the target interest rate several points below the neutral rate, creating a massive asset bubble, and the inflation rate averaged less than the consensus target rate for that entire period.  In fact, taking housing out of the measure, inflation has been below target for more than 20 years.

Why should we take housing out of the measure?  It's mostly imputed rent.

To make this easy to imagine, let's imagine a zero inflation target and zero growth.  In year 1, the average household has $50,000 income and $20,000 in cash expenses.  Additionally, the BEA notes that the household owns a home that has $15,000 in rental value, so that, while the household doesn't realize it, they have $65,000 in income and $35,000 in expenses.

In year 2, the central bank accidentally hits its target.  The household still has $50,000 income and $20,000 cash expenses.  But, the central bank notes that the household also owns a home that has $15,500 in rental value, so that, while the household doesn't realize it, they have $65,500 in income and $35,500 in expenses.

The central bank determines that they have erred by $500.  They need to pull back the amount of cash in the economy so that the household returns to a level of $65,000 and $35,000 in expenses.

Now, the problem is that the rental value has nothing to do with cash, so that the central bank can only reduce spending in other areas.  This means that when the central bank tightens policy, the household has $49,500 in income, $19,500 in cash expenses, and still has $15,500 in rental income and expense.  The central bank had to deflate the cash economy in order to meet their target.

The kicker is that the reason rent inflation is above target is because there isn't enough money to fund new construction!

*This is technically a "Housing and utilities" category, so a small part of the housing category itself is "energy", which probably adds a slight imperfection to my "PCE less food, energy, and housing" measure, which I have estimated manually.


  1. There is plenty of money as evidenced by stocks at high valuation, high corporate earnings, low interest rates, stable commodity prices, etc. The money is just in the wrong places. You lament that credit isn't available to the "middle class" without really analyzing why. It isnt some conspiracy and there are plenty of private investors who would take the "free lunch" of lending to the middle-class if it existed.

    Truth is, our economy has become more akin to "winner take all." In this world, betting on broad-based, middle class wage-driven prosperity is a mediocre bet. Pushing home values up relative to underlying rents wont solve much as that is a one-time gain. It may even be counterproductive as shifts in taxation are making home ownership an increasingly bad long-term proposition.

    Restore "middle-class" wage growth and the housing crisis will take care of itself (except in closed access cities as you well know).

    1. Two questions you might ask yourself:

      1) When those home prices were rising in 2000-2005, was it due to changing credit conditions or rising middle class prosperity?

      2) If stagnant middle class wages are the factor weighing down home prices, then why are rents increasing? Since rent has comprised a level portion of PCE for decades, it appears to be largely governed by income effects.

    2. I think 2000-05 was a story of 1) low starting house prices, 2) income gains, 3) credit availability. I don't deny credit availability can push up home prices, but i do strongly question whether that is the driver we want. We all know credit cycles can be boom-bust at times.

      We certainly have some income growth alongside rent increases. I'm not suggesting things are awful out there...just not so great that you want to run and lend to the middle-class.

      As one indicator of what the market thinks of the housing market take a look at the publicly traded residential homeowners. AMH is a good example - last math i saw suggested it trades at a 20-30% discount to a (conservative) NAV. There is simply no appetite to bet on middle-america housing.

  2. re: "Detailed PCE inflation is only updated quarterly"

    i don't know how much detail you need, but the PCE price index is updated monthly with the Income and Outlays report, coincidentally most recently for December:
    see tables 9 and 11, and their impact on tables 7 and 10

    i dont think the GDP report has much more, unless you're looking at a report i'm unaware of..

    1. and now that i read your post rather than react to your opening statement, i see you're looking for the housing component of PCE, a figure for which you're apparently backing out of the inflation adjustment made to housing & utilities in the PCE services component of GDP. and no, i don't know where you'd find a similar metric monthly.

  3. Another ace post.

    There is a deeply (and I mean Grand Canyon-Mariana Trench deep) held convention, ongoing, that the Fed is "loose."

    Cato Institute just put out a Winter issue absolutely filled with the usual anti-inflation, anti-Fed rhetoric and premises and hints a gold standard would be preferable, and if not that, straitjackets on Fed governors.

    Yet if inflation is your metric, the Fed has done a great job for 20 years.

    Add on: I think federal employees do an earnest and generally good job measuring inflation. But they cannot keep up with rapidly evolving goods, services and retail formats, which naturally normally accrue to the benefit of the consumer (outside of housing, due to property zoning).

    So likely the inflation rate, outside of housing, is near dead zero.

    Would that Cato (and other right-wingers) extend such sustained fury at property zoning, a truly important structural impediment.

  4. Hi Kevin!

    You’ve touched on some of this before, particularly re: inflation above 3% and inflation below 3%.......

    1. Whoops! Forgot to clarify that I’m TravisV.

    2. Hm. I think a lot of the relationship he talks about is probably due to the 1970s. Inflation has to get pretty high. Cyclically, rising inflation triggers monetary tightening and NGDP contraction. The second issue is in play now, but not the first, IMHO.