Source : THE AGE NEWS
The US Bureau of Economic Analysis doesn’t like the answers to the questions it is asking of inflation data it collects, so it’s changing the questions.
Not for the first time, the bureau (the BEA), which produces America’s key economic data, is planning to revise its methodology in a way that will reduce the published inflation rate that, for more than 25 years, has been the key number the US Federal Reserve Board has focused on in deciding monetary policy.
In January, without any public disclosure of the change, the bureau made a change to the way it calculates legal services costs to exclude a sudden spike in prices. The change may have shaved about 10 basis points (a tenth of a percentage point) off the published Personal Consumption Expenditures (PCE) Index that the Fed favours.
Late last month, the BEA announced changes it plans to make to the data in September, shifting the sources of data used to calculate the contributions of portfolio management fees and investment advice services, legal services and computer software and services.
Coincidentally, or otherwise, two of those three categories – portfolio management services and computer software and accessories – just happen to be two of the four inputs to the PCE data that have contributed most to PCE inflation over the past year.
The most recent headline PCE number, for May, showed inflation running at 4.1 per cent year-on-year. “Core” PCE, which excludes volatile food and energy prices, rose 0.3 percentage points between April and May and was 3.4 per cent year-on-year.
The BEA has opened itself to criticism that it is manipulating the data.
Had the BEA’s changes been made, it is estimated that it would have knocked 20 basis points off core PCE, reducing it to 3.2 per cent.
There is plenty of criticism of how the underlying data that feeds into the inflation numbers is sourced and calculated, and therefore rational reasons for trying to improve the quality of that data by tinkering with the BEA’s methodologies.
But by only including those inputs that have a relatively material impact on the inflation number, and leaving plenty of others that are also problematic untouched, the BEA has opened itself to criticism that it is manipulating the data.
Given Donald Trump’s obsession (one of many) with interest rates – he believes lowering them significantly will ignite an economic boom – it’s not only the cynical who might suspect that the data is being skewed to help his cause.
Trump doesn’t like data that casts a bad light on his administration. He fired the head of the Bureau of Labor Statistics last year after the agency produced revisions to jobs data that showed disappointing levels of jobs creation.
One of his key lieutenants, Stephen Miran (who filled a temporary vacancy on the Fed’s board until quite recently), has argued that post-pandemic statistical quirks have artificially elevated recent inflation readings, potentially distracting and misleading the Fed and preventing it from lowering interest rates. Miran voted for a rate cut at every Fed meeting he attended.
The BEA will produce revised versions of the PCE for the past five years, which could suggest that the inflation rate has been lower than previously thought during the surge in inflation that peaked in mid-2022, after global supply chains malfunctioned post-pandemic and the Russian invasion of Ukraine.
Even at 3.2 per cent in May, core PCE is still well above the Fed’s targeted inflation rate of 2 per cent, as it has been for more than five years.
Kevin Warsh, appointed the Fed’s chair by Trump with an expectation that he would deliver the rate cuts that Trump so badly wants, may be able to do something about that.
While Warsh has presented as more of an inflation hawk than a dove in his first weeks as chair, he has established five task forces to re-evaluate the way the Fed operates, one of which will review how the Fed sources, processes, and relies on data.
He has made it very clear that he isn’t a fan of the PCE data the Fed has used as its primary source for inflation data since 2000, instead preferring the “trimmed mean” published by the Dallas Fed.
The trimmed mean “trims,” in an asymmetrical fashion, the highest and lowest contributors to the inflation rate. It excludes 31 per cent of the highest price increases and 24 per cent of the biggest price falls.
Its advocates say it provides a better insight into underlying inflation by excluding what may be “one-off” price spikes or falls.
It is hardly “trimming,” however, when 55 per cent of the data is being excluded and the inputs contributing most to inflation are disproportionately removed from the calculation.
If the trimmed mean were substituted for the traditional PCE data released in May, it would have produced an annualised inflation rate of only 2.4 per cent, not the 4.1 per cent headline PCE number or the 3.4 per cent core PCE rate. With a simple re-prioritisation of data sources, the Fed would be within touching distance of its inflation target.
The major differences between recent PCE and trimmed mean readings relate to the exclusion of the impact of Trump’s tariffs on goods prices, the surge in energy costs flowing from the war on Iran and the flow-on effects to semiconductors and computer software and other IT-related costs of the boom in artificial intelligence from the trimmed mean calculation.
An argument can be made that Trump’s tariffs and the spike in energy costs are one-offs and their impacts on the inflation rate will be passing.
Trump, however, keeps adding tariffs and threatening new ones and, meanwhile, the higher cost of goods are feeding into inflation expectations.
Oil prices have retreated to pre-war levels during the current 60-day ceasefire, but even if there is no further conflict in the Middle East, the war has had major impacts on the oil market, on oil reserves and on future supply lines that have the potential to produce higher prices as the market and industry establish a new normal state.
The AI boom shows no signs of petering out, indeed its impacts are spreading deeper into the economy, beyond demand and prices for semiconductors and software and into construction and the energy and water infrastructure for data centres.
The Dallas trimmed mean, for instance, lagged the PCE index in capturing the post-pandemic surge in the inflation rate – at more than 9 per cent – because it excluded the very products most impacted by the dysfunctional supply chains.
It is interesting that it is the Dallas Fed’s methodology that Warsh has nominated as his personal preference.
The Atlanta Fed tracks nine different measures of inflation: the Dallas measure is currently producing the lowest inflation rate.
The BEA’s planned revisions to its methodology will by themselves trim published PCE inflation rates. If Warsh can convince his Fed colleagues to adopt the Dallas Fed’s trimmed mean as their key inflation metric, Trump’s inflation problem will almost disappear and his hopes for big rates cuts might be a lot closer to being realised than they appear to be today.
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