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Discovering the True Rate of Inflation: A DD on the Fed

Would have posted on r/investing, but they don't allow graphs. Read at your own risk.

So I've been reading a lot of fear-mongering and fear-downplaying as of late about the CPI, and what it actually means. There are two narratives I see about inflation around WSB:

  1. The inflation we're experiencing is transitory and should dissipate after pent-up demand is satisfied.
  2. Inflation is higher than we think it is, and will cause widespread economic damage when it runs out of control.

I decided to do some research into the questions: "how much inflation are we really experiencing?" and "is it out of line with historical inflation" to try to provide some insight into the two theses above. And also I was trying to learn SQL and this was helpful with that.

Since this is WSB, I'm going to jump right into the results and talk about methodology further down. However, its worth noting that 1) I am not using the same basket the government uses, and 2) I decided to mostly use data from the OECD, not the US government to run these numbers. This is not economist-grade research. Use carefully.


What is the actual Inflation Rate?

Based on my projections for the last 10 years, the rate of inflation may be 4.2% annually, which is significantly higher than the 1.5-2.25% the government tells us. This chart shows the total increase per quarter, with a final result of 42.7% at the beginning of Q1 2021 (100 is the base for this chart).

10 years of price increases across my basket of prices.

What does this overall picture say about our two theses?

To question 1: According to this basket of prices I analyzed, I do not believe inflation will be transitory without major government action. Inflation appeared to be picking up in the 2018-2019 period, and that is in addition to what was an already high level of inflation throughout the decade. The additional liquidity provided during the pandemic is unlikely to sink in without higher interest rates.

To question 2: I don't know what these results say about the inflation explosion thesis. You tell me. However, 2 thoughts: it doesn't seem like this new round of inflation is all that far out of line with the last 10 years. But that line is scary.

What about inflation in Housing?

Good question! That was part of the analysis, and to nobody's surprise, the price of owning a house has gone up more than almost every other measure.

A graph of inflation in housing prices, 2011-2021

That's right, it appears that it is 52% more expensive to buy a house than it was in 2011, and there was a sharp upturn during the pandemic. The same cannot be said for renters, who only experienced 37% inflation in the same period. Right now at least, it seems relatively more attractive to rent than own. What really surprised me is that rent prices continued along relatively smoothly during the pandemic.

A graph of rent prices from 2011-2021

I also looked at other things to make this analysis, but if you're an ape and therefore incapable of reading methodology, you can stop here.

How did you come up with these numbers?

I decided to create a new CPI (consumer price index) based on what people actually purchase today, rather than the selective basket the BLS uses to calculate the real CPI. However, to do this I had to use BLS data from here.

This is what the average household's spending habits look like.

To construct my basket, I took inflation data by category from the OECD and weighted it by its allocation in the average household budget. I've got everything from education to healthcare, clothes, food, cars, and entertainment, alongside the big ones discussed above.

I also broke housing out into rent costs vs ownership costs based on the percent of people who are homeowners. Then, and this is perhaps the most potentially controversial, I used the stock market as a measure of inflation for people's savings. This means that I pegged the rate of inflation allocated to savings to the price of $VTI. I justify this by thinking that the cost of investing has grown by more than 250%, which is what most people want to do with their savings. Criticize this (rightly) if you like. Lastly, I did use the entertainment producer price indexto to estimate inflation there, as I couldn't get good numbers for an entertainment CPI, but the PPI is generally correlated to the CPI, and it's a small part of the chart.

Last thing I'll note:

If you buy my argument about the inflation rate, then you'll be unhappy to compare it to wage growth. You'll see that wages have historically grown by 2%. yearly, which means that the average worker's wages have decreased about 2% yearly. That somewhat changed during the pandemic, when wages exploded. However, I thought about it for 10 seconds and realized this may be because all the low-wage workers got fired, temporarily pushing the numbers up. IDK. Rich people always win.

Alright, I'm done now. Go buy OTM PLTR calls or something. Feel free to message me if you'd like to review my data.

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