Sep 29, 2022 - Economy & Business

The weird quirk making inflation look lower

Illustration of measuring tape measuring a dollar bill

Illustration: Sarah Grillo/Axios

Friday morning, the government will release new numbers on incomes, spending and inflation for August. Analysts expect core personal consumption expenditure (PCE) inflation, the Fed's preferred measure, to come in at 4.7% over the last year.

  • But a surprising calculation quirk is pulling those numbers lower. It underscores the importance — and pitfalls — of focusing on the innards of inflation figures.

Why it matters: Over the last year, much has been said about why various forces pushing inflation up are one-offs and should be ignored. But that cuts both ways.

The details: For PCE inflation, one of the biggest downward forces is linked to purportedly falling prices in the "portfolio management and investment advice" category. They are down 18.5% just since January.

  • But it isn't that investment managers are slashing their prices. Rather, they often charge a percentage of assets under management — and asset prices have plunged.
  • For example, if someone paid their money manager 1% of assets in annual fees, but the value of their portfolio fell 25%, it would show up in the inflation data as the price of money management services falling 25%.

Whatever you think of that approach, to the degree plunging asset prices are, in a mechanical sense, flowing through to lower core prices, it means the reported inflation numbers are lower than what most people are experiencing.

  • After all, most portfolio management fees are paid by people with lots of financial assets. Rich people may be saving some money, but for a person with a modest or non-existent portfolio, it doesn't matter.
  • According to calculations by Jason Furman and Willie Powell III at Harvard Kennedy School, prices rose at a 5.3% annual rate in the April through July period if you exclude these services, not the 4.3% rate at which core prices were reported to have risen.

What's next: "Given how it is constructed, portfolio management inflation tends to track asset market performance, and is highly correlated with the equity market with a one-month lag," Deutsche Bank chief U.S. economist Matthew Luzzetti tells Axios.

  • Therefore, he doesn't expect much impact on tomorrow's August inflation numbers, since stock prices were relatively flat in July.
  • But it implies that September inflation may be misleadingly high (because stocks rose in August) and October inflation misleadingly low (because stocks plunged this month).

The big picture: To get a clear reading of inflation trends, it's important to sweat the details of how indexes are calculated. But you can't look at just the components pointing in your preferred direction.

  • As Furman notes, there has been much coverage of how quirks in the used car market have made inflation look artificially high, yet virtually none (until now!) of how portfolio management quirks may be making inflation artificially low.

The bottom line: It's important to look carefully at even the aspects of economic data that don't tell you what you want to hear.

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