President Donald Trump’s nominees to the Federal Reserve Board — Herman Cain and Stephen Moore — were both forced to withdraw by the banking establishment which rebelled against having outsiders on the Fed.
Their cardinal sin was to urge more cuts in interest rates to further stimulate the economy, disregarding fears of inflation, the institutional bugaboo of the Fed.
But now, Alan Greenspan — who led the Fed from 1987-2006 — admits that the Board’s measurement of inflation has been wrong all along, tending to exaggerate it by at least two points per year.
A column in The Wall Street Journal by Andy Kessler draws attention to an admission by Greenspan in an interview at the Wharton School that “we have a problem with measuring inflation.”
He admits that “if you had a 2 percent inflation rate as currently measured, it’s the equivalent of zero for actually what consumers are buying.”
Why? Because consumers are smart and constantly change what they buy to avoid high prices.
The traditional inflation measurement is based on a “market basket” of products. It assumes shoppers are idiots, buying the same stuff this week that they bought last week despite prices rising.
But shoppers are way smarter than that.
Recipes for dinner change to use less expensive products. New technology offers lower cost alternatives. The cost of new gadgets drops shortly after they are introduced.
Kessler writes that he believes “that all of the common measures overshoot [inflation] by at least 2 percentage points, and maybe even 5 or more.”
That means that every cost of living government program or private contract containing a cost of living adjustment is wrong and that our economy could have grown by vastly more without risking serious inflation.
Kessler estimates that a two percent adjustment downward in inflation statistics, starting in 1989 (two years after Greenspan took over) would have yielded a $26 trillion GDP by now — one-third larger than we have — one-third more for Americans to have in making ends meet.
When society and the economy change, the Federal Reserve should not be the last place to notice.
From 1987 until 2006, America’s political leadership lived in awe of Greenspan, who, in turn, lived in terror of inflation.