Inflation Update . . . Core PCE Inflation (the Fed's favorite inflation measure) remains at a 40-year high

“Core PCE” is the Fed’s Favorite measure of inflation.

Today it remains at a 40-year high (4.625%)
The last time it was this high (Feb 1989):

  • George HW Bush was a newly-sworn President (one month)
  • The Government of Poland (still communist) held its first talks with Solidarity
  • “Back to the Future” was a 4-year-old movie, very popular on both VHS & Beta
    The Fed increased the Fed Funds Rate to 9.85% to defeat it.
    Maybe this time is different.

For those who may ant a refresher:

  • “PCE Inflation” differs from “CPI inflation” because it includes all your living-costs. The primary difference is that it includes your employer’s cost of healthcare. (If healthcare costs rise 5% but your job contract mandates you pay only $300/month plus a deductible then CPI doesn’t count the increase."

  • “Core Inflation” (does not matter if it is CPI or PCE) excludes food and energy costs. Sometimes this seems like an evil plot to understate or overstate the “real” inflation rate, but the logic is much more benign. Food & gas prices tend to go both up and down. (They are not sticky.) All the other prices tend to go up and stay up.
    If those “other costs” are up 4% this year you will still pay 4% more next year, and ten years form now, and 20 years form now, and your kids will pay 4% more, and your grandkids, and greatgrand kids and so on forever. (It means those cost increases are a very different category of cost increase.)

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So you’re saying blockbuster is coming back?

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I am saying “things are worse than some people might think.”

I am also saying
“We don’t have inflation THIS HIGH very often (sample size) but the little data we do have suggests interest rate might need to (nearly) double before the this is all done.”

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Isn’t the new data coming out next week, and then Powell’s meeting as well?

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Yeah, perhaps I chose the wrong title.

Well, interest rates doubling sucks a ton. But I kind of figured the increases in costs of goods and services was here to stay regardless of what the feds do. It would seem the lesser evil would be to maintain current rates, some raising/lowering of normal proportions, to maintain employment and therefore a larger tax base. Otherwise, won’t the scales tip the other way with job losses, unemployment benefit extensions reopening the purse, and possibly deflation which would be even more disastrous?

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We don’t have many instances of inflation (CPI) > 5% but when it happened in the '80s tho I was a young boy I remember my older relatives would “hurry” to buy things, durable goods anyway because “ya won’t be able to afford them next year.”

When inflation is 5% and your bank pays 2% that can be a true statement. So the super-simple method of fighting inflation is to raise rates>CPI. (Current Fed Funds is 5%. Current CPI is 4.6%. Hypothetically the Fed could stop raising right now.)

More goes into it than that, and that’s where reducing inflation gets tricky.

  • Conventional wisdom says interest must also > the most recent high point in inflation. That implies a “terminal rate” of >7.9%

  • Powell believes that because he is also reducing the balance sheet, 7.9% will not be necessary. A lower rate may suffice.

  • And of course history shows that “last time” core PCE inflation was this high Fed Funds = 9.85% was needed to do the trick.

I am openly skeptical of Chair Powell and the current Fed, but I am guessing from the same lack of data he is, so . . . maybe their current path is sufficient.

The problem with that is that boom leads to bust.

It’s not as though we have a choice. Inflationary boom will lead to recession.
(Revert to mean. Equilibrium. That sort of thing.)
The question is

  • Do we want a really bigger long boom (which will probably mean a bigger longer recession)
  • Or should the Fed let some air out of the balloon to prevent a violent and destructive bust?

I will add here that this time around, like most times (and possibly all times) the boom was caused by an overly-stimulative Fed (not a free market thing), and thus letting the air out slowly is simply returning to the free market.

There are many ways to graph it, but they all look pretty much the same.
One way or another, that blue line will return to that red line.


Well next week we do get the updated data:

Then I believe the Fed decides to raise rates again or pause, correct? I suspect that we won’t see much of a change in inflation from the previous month. And isn’t the case that as long as the labor market remains steady and unemployment is low, along with the consumer willing and able to pay higher costs inflation will really not move much?

History shows that at some point consumers are not longer “willing and able.” For the decade pre-pandemic, the US personal savings rate ranged 7-7.5%.

  • Post pandemic it dropped to 3.5-4%. Can’t afford apples? Save less. Can’t afford gas? Put it on your credit card. Basically Americans paid for 4% inflation by reducing savings.

But that only lasts so long. Here is a family budget pie-chart chosen m/l at random.
Notice the pie wedge marked “Savings 7%?”


Mentally reduce that to 3.5% because of inflation in one year. but then inflation is goes up 3.5% on top of that and you have to reduce it some more. and again and again.

There is no way to avoid that. One way or another, sooner or later inflation will cause Americans to reduce spending in one or more of the other categories.

  • That means GDP will come down.
  • That is standards-of-living coming down. That is a recession. (inflationary booms always lead to bust.)
    It can happen sooner than people sometimes think. I noted above the average went for 7-7.5% down to 3.5-4%. The following savings rate were published by Goldman Sachs in Fe 2020, using 2019-and-earlier data

According to them 60% of US households had a negative savings rate prior to COVID. The point where inflation causes such people to buy less stuff (IOW recession) can come pretty quickly.

I don’t know if inflation (the price of apples) will move much but pretty soon, if not already, the quantity of apples bought will come down. When employers stop selling stuff. they start laying people off. It has always been that way.

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Food inflation has been the worst, right?

Despite a recent stabilization in food prices, which remained unchanged for most items in the latest inflation reading, they remain substantially higher than 2020 levels, with a notable increase of 22.3%. This surge in costs has compelled households across all income levels to make adjustments.

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I don’t know if it’s been the worst.
Food prices and energy prices are unique in that after they
up, they sometimes come back down again.

  • Food is 13.561% of CPI (8.177% food at home, 5.384% is food away from home)
  • Energy is 6.644% of CPI (including 3.194% which is gasoline.

The rest of the hypothetical market basket (79.794%) is considered “sticky.”
When the last time you heard of rent going down? Health insurance?
(more below)

This however brings up another interesting point.
If technology make thing cheaper then we must consider the following

  • some version of CPI is the only way we have to measure inflation (I am not disputing the use of CPI,) but
  • the actual effect of inflation is to undo all of the “cheapening effect” of technology plus make prices go up above and beyond that.

The modern Internet was born in 1997, (smart phones had not been invented, neither had lap tops. Google was not around. Compuserve was almost as big as AOL) yet since then inflation has totaled 93.7%.

Hello Amazon? Even books and educational supplies are more expensive these days.

Did buying books (and everything else) over the internet save us money vs book stores renting mall space? Did any technology anywhere make things cheaper in the last quart century? Ddi replacing FIVE employees with ONE make anything cheaper anywhere? It sure did! But we will never know how much because inflation undid 100% of all the “cheapening effect” of technology, plus added 93.7% to prices above and beyond that.

THAT my friends is the true cost of inflation. It is a force more powerful than the PC., the Internet, robotics and every related thing you have read about in the past 25 years.

Unless it returns to the green line. And these things tend to have momentum, past the norm line.

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Here is the chart again, with no lines at all:

I suspect in a free market, (one with no central bank or one where the central bank takes a largely "hands-off approach,) either

  • either the money supply would remain fixed relative to GDP
  • the money supply (M2) would oscillate up and own relative to GDP.

I cannot think of any economies that have such a bank, so I cannot prove it, but looking at the above chart, we can hypothesize that prior to the GFC, the US was closer to that than it is now, and compare the two periods.

Obviously we have entered a new period.
What the Fed was doing before was very different from what the Fed is doing now.
The Fed is much more interventionist than past Feds.

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And a fair question is why? I suggest it is political motivation.

Politicsl motivation?
That may or may not he too strong a term.
Clearly it is at least a bias in favor of the Keynesian school.

The Fed overdid it.
Circa 2008 they began printing fast and furious, and did. not stop when the GFC was over.

But was it a political bias?
That would be a oretty heavy charge so the standard of proof is pretty high.

I mean the timing of their actions. That they are over the top Keynesian worshipers is just their methodology.

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Janet Yellen and Jerome Powell have each confessed that they were each wrong when they each described inflation as “transitory.” Several other Keynesian economists have also admitted they were wrong at the time (eg Paul Krugman.)

It remains to be seen if they have truly reformed,
I doubt it. (As soon as SVB and Sig Bank collapsed they started printing money again.)






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