Not one person in 1,000 knows this. You can be the one. In the next 3 minutes, you can learn how the Fed misleads you about inflation and interest rates.
The Wrong Cure for Inflation
Traditional anti-inflation policy often attempts to reduce demand. Higher interest rates, spending cuts, and tax increases can make borrowing and purchasing more expensive.
If enough people are prevented from buying homes, cars, medical care, or other goods and services, demand/price pressures may decline.
Here’s the prevailing logic:
1. Prices are rising because current demand exceeds supply.
2. The Fed’s cure is to raise another price—the price of money—which raises the cost of buying things until enough people no longer can afford them.
3. Their reduced buying then reduces demand, which supposedly reduces inflation.
4. Thus, the Fed deliberately increases costs in order to reduce cost increases.
5. Further, by increasing the cost of expanding production, the Fed helps perpetuate the inflation-causing shortages they are supposed to be fighting.
Get it? Actually, we don’t get it. And you shouldn’t like it.
Because interest is not included in the official consumer-price inflation, the Fed can reduce measured inflation while households’ cost of acquiring the same goods and services rises because of higher financing costs. In short, official inflation can go down while your costs go up.
Example: Suppose the price of a house remains at $400,000. The Consumer Price Index (CPI) may say its price hasn’t risen. But if mortgage rates jump from 3% to 7%, the monthly payment required to buy that same house rises enormously.
To the buyer, that’s not an academic distinction. Housing became more expensive. But the Fed would claim there was no inflation.
Similarly with a financed car. If the sticker price stops rising but the auto loan becomes much more expensive, official inflation can improve while the purchaser’s total cost worsens.
That suggests three different concepts that routinely get blurred together:
- 1. Price inflation — the measured change in the prices included in an index such as CPI.
- 2. Financing cost — what interest adds to the cost of acquiring something.
- 3. Affordability — what the purchaser actually can afford after considering price, financing, income, taxes, etc.
The Fed principally targets the first by deliberately manipulating the second, thereby affecting the third. The Fed reduces measured inflation by making things less affordable.
If raising prices to lower prices isn’t enough misleading irony, consider this: Suppose higher rates make a $400,000 house so expensive to finance that many potential buyers disappear. Eventually the seller cuts the price to $380,000.
Official statistics see downward pressure on the house price. The prospective homeowner may say: “They knocked $20,000 off the house and added $200,000 to my lifetime interest payments.”
The exact numbers depend on the mortgage, of course, but that’s the conceptual problem. The Fed’s mandate concerns price stability, not affordability stability.
Those are not the same thing. And if our real concern about inflation is ultimately that people have difficulty affording what they need, then deliberately reducing affordability to improve an inflation statistic deserves considerably more scrutiny than it usually receives.
If there are too few houses, one “solution” is to make mortgages so expensive that fewer families can buy houses. Another is to increase the housing supply via tax incentives, and other federal rewards.
If energy is scarce, one “solution” is to suppress economic activity (force a recession) until energy demand falls. Another is to increase energy availability and efficiency, again, via tax incentives, overseas purchases and other devices.
If medical services are scarce, one “solution” is to make medical care unaffordable for more people. Another is to produce more medical care by helping to fund medical education, hospital construction, medical R&D, etc..
The second approach grows the economy. The first just renames shortages, inflations and recessions.
Pretending to address inflation by making things less affordable and less available is the ultimate treachery.
Rodger Malcolm Mitchell
