Inflation’s Shapeshifter: Measuring It the European Way and Seeing Beyond the Hype

At the heart of most financial discussions these days, inflation is the recurring boogeyman that haunts the dreams of economists and investors. A core inflation rate below 3% would be a reason for the Federal Reserve to heave a sigh of relief, and it would have a positive domino effect on stocks, sparking an uptrend and quelling consumers’ anxieties about the escalating cost of living. But can this dream become reality? It seems possible, especially if we choose to measure U.S. price changes the way Europe does.

In May, by European standards, the U.S. had already dipped below the dreaded threshold, dropping even further in June. However, a stark contrast is painted when U.S. inflation data is measured the traditional way; the figures announced last Wednesday showed core inflation reaching a significant 4.8% for June. This discrepancy stems from the different methodologies employed by the U.S. and Europe in calculating inflation. The U.S. Bureau of Labor Statistics (BLS) does calculate American price increases the European way, though this alternative is relatively less known.

It is indeed baffling to see such a radical discrepancy between the two methods, enough to throw off investors who might be inclined to believe the current consensus: that inflation is decreasing, though not as rapidly as the Fed would prefer. The alternative narrative suggested by the lower European figures may disrupt this perceived stability.

The difference primarily arises from what each measure excludes. The U.S. core inflation, which eliminates the volatile factors of food and energy, was measured at 2.6 percentage points higher than the European-style inflation, otherwise known as the Harmonized Index of Consumer Prices (HICP). This marked the greatest gap ever recorded between these two measures. The HICP excludes what is called “owners’ equivalent rent” or imputed rent, an imaginary cost that a homeowner would pay to rent their own home, which makes up about a third of the U.S. core CPI.

Inflation's Shapeshifter: Measuring It the European Way and Seeing Beyond the Hype

Removing such a contentious component, which is based on speculative calculations by homeowners on the rental value of their houses, can lower the core inflation to a more acceptable 2.3%. While it is important to consider food and oil prices due to their impact on the cost of living, their exclusion from core inflation allows a more focused view of whether the economy is generating pressures the central bank needs to mitigate.

So, why does inflation continue to be a cause for concern? The answer lies at the intersection of tradition, ignorance, and fear. The Consumer Price Index (CPI) has long been the preferred measure of inflation in the U.S., even though the Federal Reserve’s inflation target is based on the Personal Consumption Expenditures Price Index (PCE) from the Bureau of Economic Analysis. The PCE generally produces a lower figure than the CPI but still places considerable emphasis on imputed rent.

The Fed faces a challenge. Even if it were to regard the HICP as a superior measure—which it doesn’t appear to—there’s no easy path to making a change without political fallout. The inflation data is already subject to considerable scrutiny and skepticism from economists who argue that enhancements to the indexes typically result in lower inflation than previous methods.

The crux of these measurement dilemmas is determining if the economy’s underlying pressures are so robust that further restraint is necessary. If a vigorous jobs market leads to workers with larger paychecks, consumer demand could surge, allowing companies to increase prices. This scenario would compel the Fed to continue raising rates.

However, the lower core HICP inflation suggests that the robust jobs market may be less alarming than the CPI measure indicates. Hawks, however, worry that persistent above-inflation pay raises could fuel inflation, as companies pass on increased costs. This could potentially elevate inflation expectations, leading to further wage demands.

Conversely, if expensive borrowing causes companies to cut spending, hire fewer employees, and resist pay demands, wage growth could moderate and demand could decline, encouraging the Fed to relax its monetary policies—provided that the economic slowdown doesn’t turn into a recession.

Inflation's Shapeshifter: Measuring It the European Way and Seeing Beyond the Hype

While indicators often align after periods of divergence, the rent increases, which have slowed down, may cause the CPI and PCE to gravitate toward the HICP. Unfortunately, even if core inflation drops further, it will still exceed the comfort zone according to the CPI and PCE measures that the Fed and investors prioritize.

Inflation is not the sole economic indicator sending mixed signals. A multitude of indicators are telling different narratives about the state and direction of the economy, a topic I’ll revisit in the next installment of Streetwise. Meanwhile, the current inflation conundrum leaves me both concerned and confused—not an ideal state of mind when trying to predict market movements. Regardless, it’s important to remember that while the face of inflation may change depending on how we measure it, its impacts on our economy are real, persistent, and require informed interpretation and action.,This article is an original creation by If you wish to repost or share, please include an attribution to the source and provide a link to the original article.Post Link:

Like (1)
Previous July 14, 2023 5:33 pm
Next July 16, 2023 5:40 pm

Related Posts

  • Inflation is Wreaking Havoc on the American Middle Class

    In the past decade, American households have seen a dramatic erosion of their purchasing power. This is largely due to inflation, which has been steadily eroding our buying power for years now. The result of this inflationary pressure is that the middle class in America is struggling to keep up with rising costs of living. From rising food and housing prices to increasing taxes, the burden on the American middle class is becoming increasingly difficult to bear. In this article, we will explore how inflation has had a detrimental impact…

    February 10, 2023
  • 5 Proactive Steps to Shield Your Finances in a Persistent Inflation Era

    Despite the evident decrease from the 9.1% inflation spike in 2022, most consumers still feel the strain on their wallets. Research as of June 2023 indicates a staggering 61% of Americans are living paycheck to paycheck, with 21% finding it hard to meet their monthly bills. Even among the higher earners—those with incomes ranging from $50,000 to $100,000—65% are in the paycheck-to-paycheck boat. So, what exactly is going on? The Direction of Inflation Collin Crownover, PhD, a research analyst with Fidelity’s Asset Allocation Research Team, opines that the economic underpinnings…

    5 days ago
  • Dancing on the Edge: The Threat of a ‘Minsky Moment’ in the Global Economy

    While recent economic data may paint an optimistic picture of the economy, a deeper analysis reveals a more precarious situation. The University of Michigan’s consumer survey indicates consumer sentiment, current conditions and future expectations are all on the rise, albeit with 1-year inflation expectations also increasing. This paints a paradoxical picture of a booming economy in contrast to rising inflationary pressures and higher than expected core inflation. Amidst this background, investors and economists are cautiously observing a brewing ‘Minsky Moment’ – a term that resonates with unsettling echoes from the…

    July 17, 2023
  • US Debt Ceiling Deadline: Understanding X-Date

    With negotiations underway, a US default remains a low but distinct possibility. When might the default “x-date” fall – and how will markets respond? The US risks default in a matter of weeks unless Congress can reach a deal to raise the country’s borrowing limit. While negotiations are underway, if the “x-date” (see below) passes without the debt ceiling being raised, coupon payments and redemptions of Treasury securities will stop. While technical lapses have occurred – such as the 1979 check-processing glitch that delayed some redemption requests – a true…

    May 19, 2023
  • Declining Gas Prices Ignite Optimism for Unprecedented Holiday Travel: A Comprehensive Examination of the Current Fuel Economy

    This Fourth of July, motorists across the nation are gearing up for road trips and family reunions, fueled by the significant dip in gas prices compared to the previous year. This decline in fuel cost is not only revving up the holiday spirit but also making a tangible impact on people’s travel decisions. Take Mathew Alvarez, a 36-year-old machinist from Los Angeles, for instance. Last year, the record-high gas prices prevented Alvarez from making the 100-mile journey to his family in Tehachapi, California, during the holiday season. As a response…

    July 4, 2023
  • Has Inflation Peaked? Fed Officials Remain Uneasy Despite Easing Supply Chain Disruptions

    Inflation has been one of the most widely discussed topics among financial experts in the past few months. With supply chain disruptions easing and interest rates at 15-year highs, there is a sense that inflation may have peaked. However, Fed officials remain uneasy as labor markets remain tight and inflation could still spike. In this article, let’s take a closer look at the current state of inflation and what it could mean for our economy moving forward. Introduction to Inflation and Economic Factors Inflation has been a hot topic in…

    January 29, 2023
  • Understanding the Inverted Yield Curve: A Harbinger of Recession in the U.S. Economy?

    From July 2022, the US bond market has witnessed a phenomenon that has traditionally been regarded as a warning sign for the economy: an inversion of the yield curve. As of May 29, 2023, the 2-year Treasury yield topped the 10-year rate, and the 10-2 Year Treasury Yield Spread fell to -0.84%. While the yield curve inverting doesn’t guarantee an economic downturn, it’s a signal that has preceded every recession in the past 50 years, thus creating a heightened sense of concern. Understanding what the yield curve is and what…

    May 29, 2023
  • Understanding the PCE and CPI Indices: The Key Differences and Implications for Investors

    Introduction The Federal Reserve (Fed) plays a vital role in shaping the United States’ monetary policy, and one of its primary objectives is to maintain price stability. To achieve this goal, the Fed closely monitors various economic indicators, with the Personal Consumption Expenditures (PCE) and Consumer Price Index (CPI) being two of the most significant measures. In this article, we will explore the PCE and CPI indices, highlighting their differences and implications for investors. The Personal Consumption Expenditures (PCE) Index Overview The PCE index, published by the Bureau of Economic…

    April 1, 2023
  • How does the Nonfarm Payroll report affect the stock market?

    What does the Nonfarm Payroll report tell us? The Nonfarm Payroll report, also known as the Employment Situation report, provides detailed information on the employment situation in the United States. This includes the number of people employed (excluding farm workers and some other U.S. workers), the unemployment rate, and wage inflation—the rate of change in wages. It is published monthly by the Bureau of Labor Statistics (BLS), usually on the morning of the first Friday. The Nonfarm Payroll report is closely watched by investors, economists, and policymakers because it provides…

    June 1, 2023
  • Bond Market Points to Fed Standing Firm in Battle Against Inflation

    Recent economic indicators have been pointing to a growing concern over inflation. In response, the Federal Reserve has taken a firm stance against inflation and is committed to suppressing inflationary pressures. The bond market has been reflecting this commitment, providing insight into the Fed’s determination to fight inflation. Fed’s Commitment to Combat Inflation Unwavering The Federal Reserve has been steadfast in its commitment to combat inflation. This commitment is reflected in the Fed’s recent decisions to keep interest rates low and to continue its quantitative easing program. In addition, the…

    January 21, 2023

Leave a Reply

Your email address will not be published. Required fields are marked *