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The Fed Admits “We Don’t Fully Understand Inflation!”

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When the Fed admits that they don’t understand inflation...we know we’re in trouble.

During Wednesday’s press conference, Fed Chair Janet Yellen, the highest-ranked economist at the helm of the sole institution responsible for America’s monetary policy, just made an admission that should have left most Americans stunned, speechless, if not worried:  “We don’t fully understand inflation.” She continues, stating that “the shortfall of inflation this year is more of a mystery."

How are we supposed to react to this? What do you say to an institution that has the government-backed authority to experiment with and create the very thing that it does not understand--and with real devastating consequences to ordinary people? Yellen’s statements confirm the extent to which the Fed’s economic notions are completely divorced from the economic realities experienced by average Americans.

Janet Yellen on Inflation

There is a world of difference between the inflation the Fed measures versus the inflation we experience.

In other words, there is a huge difference between constructing a theory to which you expect reality to conform versus constructing a theory based on reality. The former--the top-down approach of which the Fed is guilty--simply doesn’t work.

Inflation is mysterious when clouded by complex theories, quantitative models, and calculations divorced from human experience. But when viewed empirically, it’s rather simple. Below is a chart from Goldman Sachs via Zerohedge that can explain “inflation” in a simple, clear, and direct manner.

US Inflation 2017

Here we go...and it’s this simple: under “real economic prices”...there is no inflation; but under “asset prices”...inflation is rampant.

Goldman’s take:

“The long economic cycle that we have been enjoying is, in part, a reflection of loose monetary conditions and low interest rates. Exhibit 17 is a simple but effective way to demonstrate this effect. Taking data back to 2009, the start of the period of extraordinary monetary policy, we can see a very big difference between ‘prices’ in the real economy – measures of wages, consumer price inflation, house prices, commodities – and asset prices. Also shown here is the long-run average nominal GDP growth and nominal GDP growth over this period for the US and Europe (in red). Financial assets have significantly outstripped both nominal GDP growth and inflation in the real economy, largely as a result of rates staying low.”

In an article titled Don’t Believe Those Inflation Numbers published by, Mark Brandly explains it in simple terms as he saw it at the time of his writing:

Food and energy prices are soaring. Inflation is squeezing consumers and roiling financial markets. Official pronouncements are failing to ease inflation fears. Of course, at all times, some prices are rising faster than other prices. Prices don't rise in tandem. Inflation always affects some goods more than others.

Omitting volatile prices from the estimates is simply a way to discount inflation's effects on the public.

Did you catch that last point? If we cannot measure inflation in terms of its real impact on people, then we are discounting human experience by reducing a real qualitative (and sometimes painful) effect to a quantitative figure (a mere number).

He then goes on to explain the government’s use of the CPI as a means of advancing government’s agenda at the expense of its people’s interests.

The CPI is a government statistic, and since the government's expansionary monetary policy creates the inflation, officials have an incentive to underestimate these numbers. Underreporting inflation helps government officials in at least three ways.

  • First of all, it provides more favorable economic news. Elected officials want to report and take credit for any positive economic announcements.
  • Second, if the government reports a rate of inflation that is lower than the actual inflation rate, this will increase tax revenues through bracket creep. If the actual inflation rate is 10%, but the measured rate of inflation is 4%, some taxpayers will be pushed into higher tax brackets even though their real income has not increased.
  • And third, a lower reported inflation statistic reduces government spending by limiting the spending increases that are tied to inflation. The state can take credit for cost of living adjustments that are allegedly keeping up with inflation although in real terms the payments are falling.

My point is that given the incentives facing government officials, we should be reluctant to put any credence in government statistics.

So the next time a government official or central banker tells you that they don’t understand inflation, it usually means one of two things: either they are lying, or they’ve lost their grip on reality. Either way, you’re screwed.

That is, unless you’ve parked your money outside of the system they’ve created for you.

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All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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