Sic Semper Tyrannis

Most people know that the Fed looks at inflation indicators to help it determine what to do next regarding monetary policy (mainly, setting interest rates). Bandied about quite often in covering the Fed are the CPI (Consumer Price Index), and core-CPI (CPI with energy and food stripped out).

But did you know the Fed doesn't even primarily use these metrics when attempting to get a grip on inflation? In fact, it uses something called the PCE---The "Personal Consumption Expenditures" metric, from the GDP report (actually, it looks at the core-PCE, which stands akin to core-CPI in stripping out food and energy).

Follow up:

"That still doesn't explain a damn thing, " you say? Well, this page has a nice little tutorial on the PCE:

PCE is the amount of money individuals spend on goods and services. It's the single largest component of the GDP. For example, the government's latest estimate of fourth-quarter GDP, released this morning, is $9.1 trillion, of which PCE accounts for $6.1 trillion. The chain-type price index for PCE measures the inflation rate for those expenditures.

So why the change? The report says ... that "the chain-type price index for PCE draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI."

The PCE deflator is better than the CPI, the Fed says, mainly because it better accounts for the fact that, as prices of goods and services change, people's spending habits change. For example, if apple prices increase, people tend to buy fewer apples but more oranges. (Improvements to the CPI in recent years have moved it in this direction, but it continues to track a fixed basket of goods and services, while the PCE deflator tracks a variable basket.)

For those who have seen plenty of my commentary (and a little is more than enough, I'm sure), you know that this is a huge pet peeve of mine: metrics like the PCE try to discount the substitution in goods purchasing that people undergo when they can't afford the stuff they used to buy. This isn't a good thing; it means the PCE, inasmuch as it does this, is measuring the cost of survival, not the cost of living.

In the 90's even the BLS switched to accounting for a substitution effect in the CPI by using geometric weighting (a mathematical trick---more on this some other time)---but even the CPI doesn't go to the extent of frequently shifting the basket of goods to stack the results as needed.

[Incidentally, measuring the cost of survival as opposed to the cost of living would be akin to the government measuring how hard it can push on the citizenry economically.]

So, it would appear that the Fed is simply introducing even more downward bias than they can get out of the BLS's CPI:

This way of measuring inflation "avoids some of the upward bias associated with the fixed-weight nature of the CPI," the Humphrey-Hawkins report says. Indeed, as this chart shows, the chain-type price index for PCE has generally trailed the CPI over the last 10 years. In the last two years, the gap has been particularly wide.

"Avoids some of the upward bias"---Technically this is true; of course much of it is justified upward bias. It's what we were trying to measure in the first place---the rising cost of living, as evidenced by general price increases!

And of course, you can see the divergence mentioned in the graph above (or one of the two in the article); it looks like the core-PCE lowballed inflation by a good half a percent in the second half of the 90s---and this is compared to the already-gamed core-CPI!

Add this to what AD readers already know about how true inflation has been subverted, and you've got some Soviet-scale economic propaganda on your hands.

So was switching to the PCE outrageous? Probably. But be heartened: at least someone in the Fed complex has (had?) a conscience:

The wisdom of the shift, however, is debatable. A recent paper by the Kansas City Fed concluded that, despite its shortcomings, the CPI is better than the PCE deflator, mainly because it measures prices more accurately.

Measuring prices---that thing we were supposed to be doing in the first place---rather than smoothing them downward. How novel. I wonder if that report's authors still have those cushy Fed jobs...

This is perhaps the part I like best about the whole travesty:

Additionally, the PCE chain-type price index is based on a broader set of expenditures than the CPI. And historical data can be revised more easily than CPI historical data, leading to "a more consistent series over time," the FOMC says.

Excuse me if I'm not ecstatic at the prospect of the government moving towards greater ease of re-writing history in its own favor.

But now for the real coup de grace of this post:

Even with manipulated CPI, manipulated core CPI, and ultimately a manipulated PCE, inflation is still accelerating and is, as the Fed readily admits, "out of its comfort zone" at 2.5%.

I've said it before and I'll say it again: why don't they just set it to 1% and be done with it?

They could change its name to the "one percent indicator" (any resembleance to executive-branch doctrine, past, present, or future, is purely coincedental).