Earth To Fed: Inflation Mandate Has Been Met

Submitted by Joseph Carson, former chief economist at AllianceBernstein

At this week’s Fed’s annual Jackson Hole conference Federal Reserve Chairman Jerome Powell is expected to announce a new policy approach that is intended to give policymakers more flexibility and time to achieve their inflation mandate. The irony is the proposed change is not necessary as the inflation mandate has been met. The problem is policymakers are not aware of it.

Inflation Measurement

The Federal Government statistical branches publish several measures of inflation. Among the most important are the consumer price index (CPI) and the personal consumption deflator (PCE). Accuracy is the most important criterion of inflation measurement, and both the CPI and PCE fail badly on this basic principle.

The use of non-market prices creates accuracy problems for both measures. Both measures base their estimates of housing inflation on what people would pay to rent their house, and not based on actual transaction prices.

But the PCE, which gets 70% of its prices from the CPI, also includes items or services provided to people by business and government. That creates another measurement issue because these items are not “sold” to the consumer.

This runs counter to the basic tenet of inflation measurement. That is inflation indexes are meant to capture what people pay for something, not what they may, could, or will pay.

Critics would argue it’s not the Fed’s job to measure inflation. That is true. But that didn’t stop Federal Reserve Chairman Alan Greenspan in the mid-1990s to argue before Congress that the CPI was overstating actual inflation. That testimony compelled Congress to create the Boskin Commission, which produced a series of recommendations designed to eliminate the presumed “overstatement” of the CPI.

Mr. Greenspan questioned the accuracy of reported inflation long before targeting inflation was a Fed policy tool. One would think the new generation of policymakers would be even more curious over accurate price measurement since it’s their target for policy success or failure.

The fact that core CPI, even with its downward bias on housing inflation, has been running above the 2% target for 4 of the past 5 years before the pandemic should be sufficient evidence that there is nothing wrong with the policy approach.

The irony in this is that policymakers have spent a year or more on a comprehensive review of its policy approach so that they could have more success in achieving their inflation target. And all along the Fed has hit and exceeded the inflation target and policymakers don’t even know it.