Then Federal Reserve Chairwoman Janet Yelln,
March 2016 FOMC Press Conference: FED_9638

If prices rise, but the government doesn’t measure it, does inflation exist? There are major holes in the government’s measurement of inflation. Lisa Beilfuss explains in Barron’s here:

There are economic models, and there is real life.

Over the past week alone, the price of corn rose 8% to the highest level since 2013, while soybeans and wheat prices hit their highest points since 2014. The CRB foodstuff index, which includes hogs, butter, and sugar, in addition to grains and other agricultural commodities, is up 15% this year and trading at the highest level since summer 2012. Grocery prices are in turn at seven-year highs. Meanwhile, the price of an existing home surged 17% in March from a year ago—the fastest pace on record.

The official inflation numbers favored by policy makers, and thus the focus of traders and investors, don’t exactly capture those stark price increases. The Federal Reserve and many economists emphasize core inflation, or indexes that exclude food (and energy) prices, because those components can be volatile. As for housing, government economists consider homes an asset, not a good or service that is consumed, and so home prices don’t directly figure into carefully watched inflation gauges.

Ignoring such price changes when they are moving persistently and significantly leaves a major blind spot, setting up a disconnect between what official stats say and what people and businesses feel. Consider that food and housing together represent 27% and 33% of household income and spending, respectively, Labor Department data show. The problem worth contemplating is that those real-world prices shape the inflation expectations that wind up determining actual inflation. Here, perception becomes reality.

Francesco D’Acunto, a professor at Boston College, has found that inflation expectations are shaped by the price changes consumers face specifically while grocery shopping. Grocery price inflation is at this point running about 3%, meaning consumers believe inflation is running about double the reported core consumer-price-index rate, he says. The average person probably doesn’t consider supply-chain issues that have helped push the price of pork chops 9% higher, and D’Acunto’s research shows it takes six to 12 months before inflation expectations change dramatically. Given food increases to date, that point is two to three months out, he says.

“What matters is what households think,” says D’Acunto. Excluding the very items to which consumers are most exposed means policy makers may “find themselves basing policy on assumptions that are totally off,” he says.

Read more here.