Australia markets closed
• ### ALL ORDS

7,890.10
+30.70 (+0.39%)

• ### AUD/USD

0.6499
-0.0002 (-0.04%)

• ### ASX 200

7,680.60
+31.00 (+0.41%)

• ### OIL

73.13
+0.19 (+0.26%)

• ### GOLD

2,448.50
+4.10 (+0.17%)

• ### Bitcoin AUD

86,448.89
+5,251.09 (+6.47%)

1,308.28
0.00 (0.00%)

# Inflation: Why headline numbers on rising costs don't always reflect the real world

It's time to have some fun with numbers.

Specifically, with the cost-of-living numbers that so many people — including the Federal Reserve’s board of governors — pay so much attention to.

What I’m about to show you is a classic example of how the headline numbers make the big news — but that sometimes, you need to dig into more detailed numbers to figure out what’s really going on.

Let’s start with the Consumer Price Index numbers released by the federal Bureau of Labor Statistics on May 10. The headline number was 4.9%. However, even though that’s the 12-month number, it’s clearly not the amount by which the CPI is rising these days.

How do I know that?

By looking at the month-by-month numbers and using some common sense.

Yes, the monthly changes add up to the headline 4.9% number. But the detailed numbers show that 2.1% of that 4.9%—almost 43% of the total increase—came in just two of the 12 months: May and June of last year.

Since the big 1.2% jump in June, the 10 months from July through April ran up a total increase of only 2.8%.

Now, let’s do something unconventional but logical, using an approach I learned recently from Campbell Harvey, a finance professor at Duke University’s Fuqua School of Business.

Instead of being bound by the conventional 12-month number, let’s take the 10- month number and annualize it. By annualize, I mean expand the 10-month number to 12 months. That produces a 3.36% number, which we’ll call 3.4% to keep things simple. That’s a more accurate reflection of what’s going on in the economy now than the 4.9% number is.

Yes, 3.4% is still a high number compared to what we’d gotten used to before inflation took off about two years ago. But 3.4% is a lot less scary than 4.9%. And it’s a lot more realistic.

Now, we come to a far less well-known, but very important inflation metric: the Personal Consumption Expenditures numbers from a different federal agency, the Bureau of Economic Analysis.

The PCE numbers, despite being little-known to the general public, are the inflation metric that the Federal Reserve uses. When you hear about the Fed wanting to get inflation down to 2%, it’s talking about PCE numbers, not Consumer Price Index numbers.

Because the Bureau of Labor Statistics and Bureau of Economic Analysis release information on different days with different lag times, the most current PCE numbers we have are for March.

The headline number was 4.2%. But if you start counting in July—a month that saw the PCE drop by 0.1%—you get a nine-month total increase of only 2.3%. If you annualize that nine-month number into a 12-month number, you get an increase of just over 3%—3.06%, which we’ll round to 3.1%.

That’s not the Fed’s desired 2%—but it’s considerably closer than the headline 4.2% number is.

Why am I starting my math in July rather than using the full 12-month period? Because using the 12-month number doesn't reflect what's going on now, but starting in July does. Just as with the Consumer Price Index, it’s a judgment call.

Looking at the monthly numbers, you see that things have changed dramatically since the big run-up in June.

No, I’m not trying to shill for the Federal Reserve or the Biden Administration and saying that inflation is totally under control and that everything is fine. But you can see that during the past 9 or 10 months, depending on which metric you use, inflation has fallen sharply.

So if you want to know what’s going on now, as opposed to what’s happened in the past, that’s a better way to look at things than using the arbitrary 12 month convention.

A final note: I’m sure that if you went back a few years ago when inflation was starting to kick in, you’d see that using 12-month numbers would have hidden the fact that inflation was in the process of rising sharply.

Why didn’t I write about this at the time? Because until I talked with Prof. Harvey of Duke, it had never occurred to me to dig into the details of cost-of-living numbers.

Now, I’ve got a reason to do it. And you do, too.

Allan Sloan, who has written about business for more than 50 years, is a seven-time winner of the Gerald Loeb Award, business journalism’s highest honor.