Real Inflation – Why It May Be Higher Than the Headline Number

Transitory. The Federal Reserve has used that word ad nauseam all year long to describe inflation. But when you consider the statistics, we believe inflation has been anything but transitory in 2021.

Our central bank’s favorite inflation indicator is the Personal Consumption Expenditures (PCE) price index. The Fed’s long-term inflation goal is always 2%, but when the PCE price index rose 3.6% in April, 4.0% in June, and 4.4% in September, the Fed still maintained inflation was transitory. The PCE price index went on to increase 5.0% in October and 5.7% in November.[1]

Another example: The Bureau of Labor Statistics’ Consumer Price Index (CPI) is largely regarded as the people’s gauge for inflation, as it measures Americans’ price for goods. Well, after a 0.8% month-over-month increase in November, CPI has soared 6.8% in the past 12 months. To put this into perspective, that’s the most significant 12-month jump since June 1982.[2]

In our opinion, inflation wasn’t transitory in 2021; instead, inflation rose at a rapid clip.

Now, what’s scary about the recent inflation data—PCE and CPI included—is that it may not reflect real inflation. In other words, prices may be higher than what the data indicate, and inflation may be worse, much worse than it currently appears.

The reality is there has been controversy over how CPI is calculated for decades, as the methodology to calculate CPI has been revised on several occasions. Specifically, the CPI was previously calculated based on what Americans pay for goods and services, or the cost of goods index (COGI). Today, CPI is mainly measured based on what it costs an individual to retain a constant standard of living, or the cost of living index (COLI).

The Bureau of Labor Statistics claims the new iteration of the CPI is more accurate, removing the items that overstated inflation. Critics of the more contemporary methodology, though, argue the CPI now understates real inflationary pressures.

Interestingly, one such critic, economist Walter “John” Williams, has pointed out that if inflation were calculated based on the 1980s’ methodologies, today’s inflation would be nearly 15%! Donald Klepper-Smith, an economist for DataCore Partners, concurs with this assessment, noting that CPI would be about 14.5% today based on 1980s’ standards.[3]

As an example, consider how housing is calculated concerning inflation. Rather than measuring how much it costs an individual to own a home, the new methodology measures what homeowners can charge to rent their home. Williams claims this switch in housing costs alone decreased the CPI by 1.5 percentage points.3

Based on the recent Thumbtacks Home Care Price Index, William’s claims don’t seem too farfetched. The index revealed that home maintenance costs are anticipated to soar 9.3% in 2021 compared to 2020, with most homeowners’ expenses up $450 to a total of nearly $5,000. Angi’s 2021 State of Home Spending Report also noted that home improvement costs soared 25% year-over-year to more than $10,000 this year.[4]

The problem with underscoring inflation is that it doesn’t give the complete picture of what consumers are experiencing at the pump, in grocery stores, with home maintenance, etc. Rising energy prices alone are anticipated to eat away at Americans’ buying power, simply given that it’s projected to cost 30% more to heat your home with natural gas, 54% more with propane, and 43% more with oil this winter.[5]

And while the Fed has finally admitted that inflation isn’t transitory and plans to curtail its quantitative easing and raise key interest rates in 2022, it may be too little too late for many Americans who already feel the pinch of soaring prices. As the comedian George Gobel once stated, “If inflation continues to soar, you’re going to have to work like a dog just to live like one.”

If you’re concerned about how inflation could chip away at your finances and hinder you from reaching your financial goals, give us a call at Nicollet Investment Management. We’d be happy to discuss your situation and help you develop a personal financial plan that accounts for inflation.

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[1] https://www.bea.gov/data/personal-consumption-expenditures-price-index

[2] https://www.bls.gov/news.release/pdf/cpi.pdf

[3] https://yankeeinstitute.org/2021/12/15/inflation-may-be-much-higher-than-reported-and-that-could-hurt-seniors-and-the-poor/?utm_source=rss&utm_medium=rss&utm_campaign=inflation-may-be-much-higher-than-reported-and-that-could-hurt-seniors-and-the-poor

[4] https://news.yahoo.com/average-cost-home-repairs-higher-210149345.html

[5] https://www.cnbc.com/2021/12/10/you-could-be-due-for-a-big-heating-bill-this-winter-what-to-know.html