Moody's Talks - Inside Economics - Data Deep Dive: Consumer Price Index

Episode Date: February 11, 2022

Mark, Ryan, and Cris discuss the latest economic statistics in great detail. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and this is a special edition of Inside Economics, something new. We're going to call it Data Deep Dive, and we're going to dive deep into the bowels of the key economic statistics. And I think it's appropriate to begin with the Consumer Price Index, CPI, obviously a very important statistic, particularly top of mind these days. And the idea here is to really give you a So if you don't like wonk, then you know, you don't, don't listen, but we're going to give you a really wonky perspective on on this data and I think the way we're going to proceed is Ryan, I'm going to let you actually did I introduce you guys? I'm not sure I did I got I got Chris Duretties the deputy chief economist of course the co-host and Ryan Sweet Director of Real Time Economics also a co-host. We're getting pretty familiar here. So I'm going to go to you first Ryan and And let you riff a bit about the CPI and tell us about the index. And anything you think is important in terms of its construction, any pitfalls,

you know, anything you want to say. And then we'll let Chris fill in the blanks. And then I'll clean up anything that's missing after that. And then we'll see where we go from there. So, Ryan? Sounds good. So the consumer price index is a measure of prices, consumers pay. So what you and I are paying.

It is a very pretty detailed. There's all different kinds of measures of consumer prices. So this one gets the most attention in the press, the consumer price index. There's a sister type of measure of consumer prices. That's the personal consumption expenditure deflator. That's the Fed's preferred measure. But with regards to the CPI, how it's constructed is it's survey-based. The BLS sends people out.

They buy the same basket of goods each month, and they just record how prices have changed. It uses fixed weights. So every two years, the BLS will update the weights, so the relative importance of each component based on our spending pattern. So recently, they just changed the weights based on spending patterns in 2019, 2020, which includes the pandemic. So we saw a shift for a greater weight on good spending, so stuff and a smaller weight on services. So the CPI measures both goods prices and services prices. And one of the biggest contributors to the CPI, one of the most important components is rents, tenant rents and then something called owner's equivalent rent.

And you guys might have to help me out. I always have a hard time explaining exactly what that is. It's essentially a rent that you would pay for renting your home out. Yeah, that's fair. Yeah, that's fair. Yeah, maybe Chris is the housing expert. So we'll explain that in a little bit more detail. I do want to say you did mention.

that it's fixed weights. The weights are based on the spending patterns of consumers. So what percent of the consumer dollar goes to purchasing a vehicle, going to college, buying a hot dog, you know, whatever it is we spend our money on. And they changed those weights to reflect consumer spending patterns every couple of years. And they just did that with the January 2020

Consumer Price Index release. And they increased the weight. And I know this number because I was doing some calculations on commodities, stuff, goods by 1.7 percentage points. So that means our spending on commodities increased by 1.7 percentage points over the share that prevailed prior to this, this recent basket. And services went down, you know, because it all has to add up to 100%. It went down 1.7 percentage points. And so that was a big change in the index. Sorry, just to elaborate. No, sure.

And some of the pitfalls is, again, they use fixed weights. So our spending shifts, you know, from month to month. And that's where the personal consumption expenditure of flier, the PC deflator differs. Like those weights change on a monthly basis based on spending patterns. Some other pitfalls or shortfalls are. So that's an important point too, right, Ryan? Because, you know, you know, generally if the price of something rises, people buy less of it or they substitute for something else. A price of an apple goes up, you go buy an orange if it didn't go up in price.

But those changes month to month aren't reflected in the CPI because they're fixed weight. Whereas in the PCE, that shift in consumption patterns along the way are captured. That's why generally in a rising rate, a rising inflation environment, the CPI probably overstates the case because people are, you know, lumber prices went up and I know my neighbor decided not to build their deck because it would. it costs too much, so they stopped buying lumber, right? But that's not reflected in the CPI. Correct. And another pitfall or shortfall is a survey, it's survey-based. So response rates can matter a lot. So if you get a higher response rate, the more accurate the data is when you dig through some of the components, particularly physician prices, so medical prices, the response rate has been dropping for the last several years. I think it's around 40%. So it's getting

really low. And that kind of makes, you know, the data a little bit less reliable and why we always got to take each number with a little bit of grain of salt when it comes to that. The way to look at it, you can look at a month-to-month basis. So, you know, what did prices, you know, do between December and January, for example, year over year? You know, what was the CPI? How much did it increase or decrease relative to last January? And then you can strip out food and energy, and this is what economists call the core CPI, and we strip out food energy because these are very volatile prices. So if you want to get a good read of what underlying or trend inflation is, you look at the core CPI. Interesting point on that. I think the reason why

economists like looking at core CPI, X food and energy or core consumer expenditure deflator, that's the actual preferred measure the Fed uses when trying to gauge where they should be on monetary policy interest rates is because that is the best measure to help understand where inflation is headed. It does the best in terms of forecasting where you're headed in terms of inflation. Because oil prices go up, gasoline prices go up, food prices go up and down and all around, and they don't really tell you anything about what's going to happen next month or next quarter or next year. But the core is more stable, more sticky. You know, prices don't, inflation doesn't change as much. And therefore, that gives you a better sense

of where things are headed. So that's what they focus on that. No, go ahead. I was just going to say that helps to separate out the signal from the noise. Yeah, good way of saying it. Yep, absolutely. Okay. Okay, that was good to summary.

There's a lot of moving parts there. Chris, anything you want to grab onto and explain in more detail? Or did Ryan miss anything you'd like to point out? He did a great job. I guess some things I'd point out. One, I think this is probably one of the toughest problems in all of economics in terms of measuring prices. It sounds like it should be easy, but there are a lot of moving parts, as you mentioned.

One that you referred to is just the basket, the weights themselves. And I think one important thing to point out is that the CPI, that headline number, is kind of this economy-wide basket of consumption. It actually doesn't refer to any one individual. There's no one, there's unlikely to be anyone who actually consumes that amount of medical services, use cars, lodging away from home. So I get this question a lot with clients. Your personal CPI is going to differ, right, based on your own individual basket. So if you were like me, the first thing I did yesterday when the CPI came out, I put my own weights.

Boy, that is kind of, kind of, I know. Pretty cool, actually. And my own personal inflation is higher. It's about 8%. Oh, interesting. You know. Can you send that spread is it a spread sheet, Chris? Sure, sure. Can you send that to me? I think that was really cool. We had a tool like that up on economic view years and years and years ago where people were able to adjust the weights based on their own spending powers like Chris did. And it shows you, you know, what the CPI is, your personal CPI. And then I think we had, you know, like the average CPI for income cohorts. You can kind of see what, you know, how you fare. That is. Well, how do you know what you're spending. Is that just your intuition? Estimated. Estimated. Oh, yes. I'm estimated.

You know, I do the shopping, so I have a pretty good idea of what, what's going on. But, you know, I learned that I need to cut back on our meat budget, and we have to increase our alcoholic beverages. Bring down the, yeah, you've got to get your inflation rate down. Yeah. I don't know about the medical expenses later on, but. Yeah. So I think that's one really important point. The inflation. rate really depends on the demographic or the population that you're looking at. So we work with a lot of lenders, for example. If they're catering to certain demographics, you know, the inflation is going to have some differential effects. The second point I'd make just in terms of the complexity is around quality adjustments, right? And I think this is something that gets lost as well. But, you know, if we're talking about commodities, right, a bag of

rice, a pound of rice, yeah, that's consistent from period to period. So measuring the price change is pretty easy. If you're talking about anything a little bit more complex, electronics, a computer smartphone, even a house, right? There are a lot of moving parts there in terms of quality adjustments. Those things age, perhaps. They have different features. So this is, I think, one of the toughest problems that the BLS researchers face is how do you quality adjust, the items. How do you compare a smartphone from last year to this year's model, right? They may be at the same price point anomaly, but if this year's phone does a lot more, has a lot more features, then actually the price has gone down. Right. So that's a challenge. I think you do see that

from time to time as you look at the different components that things move around in different ways and it's really hard to pin down what those quality adjustments are. And that that does refer back to housing and rents. So that's how I would tie in here. So Ryan mentioned this owner's equivalent rent is a significant component in the overall CPI. I think it's about 25% of the expenditures is housing related. So the BLS does a really great job in terms of being very transparent in terms of their

methodology. So if you really want to know all the details here, you can go in and get a lot of details. The housing is complex. The housing metrics are really consistent. complex. One, because you have homeowners and renters, right? So, for example, the, the weights for housing actually come from the consumer expenditure survey, where we go out and ask people how much they spend on each good. So homeowners versus renters, we have some idea of the weights. But the actual values, the prices are from a rental survey, right? So that

actually is a survey that is conducted throughout the year where, again, the BLS surveyors will go out, look at different properties in different markets, and they're trying to come up with a value of the rents. And here, too, it's really complicated because you have changes in square footage, position, right? Even a townhouse, if you think about it, you have an end unit versus another unit that's a little bit different. You have to all these compensating factors. So for that reason, right, it's not an easy problem. So I think we definitely need to take the numbers with a grain of salt, but it does give a good broad sense of price activity, certainly. Yeah, it's funny.

Hopefully I didn't take too much time there. No, no, that was great. I mean, I do hear always criticism of the inflation numbers. That's not my inflation rate. Right. You're all right. But I don't think people, like you say, recognize that their basket of spending is different than the typical person in America.

And also the quality adjustments kind of blow people's minds. You know, but you think about that for three seconds or even a second, go, oh, yes, of course. I mean, a vehicle today is not the same vehicle a year ago or certainly 30 years ago. So you got to correct for that. I mean, you know, make sure that you get that quality adjustment. And people don't really, you know, get that either. But I think the CPI does a pretty good job. One other point, I don't think just to fill in the blanks a little bit more, the CPI is based on out of

pocket expenses, right? So you're shelling out on things and not what your actual expenditures are because the government also does spending on your behalf, like or insurance companies, right? So in a case of healthcare. And that's why the weight on health care, medical care is a lot lower in the CPI than it is in the core or in the consumer expenditure deflator and housing is much more. more important in the CPI because we shell out cash for rent than it is in the PCE, the core consumer expenditure deflator. And that's, you know, one of the reasons why, along with the way

the weights are calculated, the inflation rate as measured by the CPI tends to be got about a quarter percentage point per annum higher than on the core, on the consumer expenditure deflator. Although, like right now, that gap is likely to get a lot wider because the cost of housing rank growth is very, very strong and going to remain, continue to get stronger because of the lack of affordable housing and low vacancy rates. Whereas medical care, well, that might pick up a little bit too, but it's been very low. And so that the gap there is quite big and getting bigger. And because of the different weights, you're going to might see a larger gap between inflation as measured by the CPI as compared to the PCE. deflator, which again is the Fed's preferred measure. But it always wasn't.

The Fed used to look at the CPI and then Greenspan, Alan Greenspan, Alan Greenspan, I think 2000, 2001 switched the Fed's measure from the CPI toward to the PCE deflator. Oh, is that? Yeah, I've forgotten that. That's right. Yeah. It was Greenspan that did that. Yeah.

I think it was the appropriate move. I mean, I think, oh, I agree. Yeah. Because it's a, it's just a better measure of inflation because of the, the particularly because of the waiting and in the overall basket of goods. Okay, I think that was pretty down and dirty, wasn't it, with the CPI? Was there anything else that we missed Ryan or Chris that you want to talk about, bring forward? I can't think of anything. I think that was pretty good. Unless you really want to get into the price and the C.S. Really deep, really deep. New

products. That's also a problem, right? Because you have the introvert. of new products and services, and that doesn't get into the CPI right away. And generally, those new products and services that are, you know, higher quality, lower price than the existing product that it might be substituting for. And so that's another reason why generally these measures of inflation like the CPI overstate the case, that they're not really capturing the effects of the new products and services, at least not quickly, it happens only with a lag. with a lag. So that's another thing to consider. Actually, I do remember back, and I think this goes

back to when Greenspan made this change, there was a commission that investigated the inflation measures and strongly argued that the CPI was overstating inflation. This was, I think, Michael Boskin, who was like the CEA chair under Bush 1 or something. He had that commission. And they use that as a basis for making this switch from the CPI to the PCE in terms of setting monetary policy. I'm sorry, interrupted you, Ryan. Did you want to say? I'm just going to say the CPI does feed in other data. So the PCE deflator uses the CPI as source data along with other measure, like the producer price index. So CPI does end up in other spots. Yeah, good. Okay, I think that was a pretty deep deep dive on the CPI. I'm sure the real wonks out there might we might hear from them

and they'll correct us if we got anything wrong or if we missed anything. But really curious, you, the listener, what do you think of this? Do you think it's useful? Let us know because this is an experiment. We're just really curious whether you find this valuable or not. And Ryan, are we going to put this up on EV, economic view for folks so that when they go to the economic release, they can listen to this podcast to get a deeper dive. Is that we're going to do that? That's a great idea. We can put it in, uh, on economic view. We have that definition tab. Yeah, exactly. We'll put it right there. Okay, perfect. Excellent. Okay, good. Well, uh, that, we'll call this the, the, the, the, the, a mini podcast. Uh, I hope, found it useful and we'll talk to you

soon. Take care now. Bye, bye.