Over the last couple of years, many economists and investors have criticized the Federal Reserve for failing to tackle inflation earlier.
In March 2020, the federal funds rate was slashed to nearly 0% in response to COVID-19. By March 2021, inflation reached 2.6%. Two months later, it hit 5%. By March 2022, inflation reached 8.5%. Only then, when inflation was already reaching multi-decade highs, the Fed decided to act, opting to increase the federal funds rate by 75 basis points.
It was too late, though, and inflation continued to increase, reaching an apex of 9.1% by June 2022. In total, the Federal Reserve has increased the federal funds rate 11 times over the last year and a half, resulting in a 5.25-5.5% benchmark rate, the highest in 22 years.
The narrative is widely known, yet the underlying dynamics of inflation and the timing of the Fed’s response remain perplexing. Ed Coulson, Director of the Center for Real Estate at the University of California-Irvine, suggested in a recent interview with the Los Angeles Daily News that our grasp of these events is hampered by fundamental issues with how we measure inflation.
Has the Fed Been Misreading Inflation All Along?
According to Coulson, the crux of the issue is that consumer price index (CPI) data shouldn’t be used as a macroeconomic policy advisor due to its sluggish nature.
Inflation, as measured by the CPI, starts with a market basket of goods and services, representing typical purchases by consumers, as determined by the Consumer Expenditure Surveys conducted by the Bureau of Labor Statistics (BLS). Each month, the BLS gathers prices for approximately 80,000 items from various sources, including retail stores, service establishments, online sales, and, perhaps most critically, rental units. These items are weighted according to their importance in average household spending, and adjustments are made to account for quality changes in goods and services.
Rental prices, in…