Inflation plays a key role in the monetary policy decisions of the Federal Reserve. The Fed’s mandate is maximum employment and stable prices. In its infinite wisdom the Fed has decided that the definition of price stability means 2% inflation. How the Fed gets away with defining an inflation rate that wipes out about half the value of a dollar over a 30-year period as price stability is truly bewildering, but I’ll leave that topic for another day.
Since professors Bernanke & Yellen took over the Fed, the central bank has been obsessed with hitting its self-imposed 2% inflation target. The Fed is so obsessed with the target that it wants to nail it down to the decimal point. Fed officials regularly tell the public that monetary policy should remain ultra-loose because inflation is a couple of tenths of a percentage point below the 2% target.
It may sound absurd to you and I, but sadly it is a true. What is most frustrating about the Fed’s 2% inflation obsession is that if the CPI included goods and services that consumers actually buy, inflation would already be above the 2% target.
One of the major components of inflation is the cost of a home, but instead of using the actual price of homes in the inflation index, the Bureau of Labor Statistics (BLS) uses something called owners’ equivalent rent (OER). OER is a made up number. It has nothing to do with the price of tea in China.
When you include actual home prices in the inflation calculation, you find that inflation has been rising much faster over recent years than the headline numbers would lead one to believe. Looking at core inflation (the Fed’s preferred measure), and using actual home prices in the calculation, core inflation is running at 2.8% compared to the 1.8% rate that is reported by the BLS.