Are We Measuring Inflation Correctly?

Inflation always seems to be the elephant in the room, it is the topic of discussion on every mainstream financial media outlet. As I write this article, I can already see the headlines for the upcoming trading week, "Should we be concerned with impending inflation?". The topic of rising inflation is every economists favourite past time and yet inflation in consumer prices never seems to show up.

Canadian and American central banks have been fixated on a 2% yearly inflation rate for as long as I can remember, however, inflation has averaged well below that figure for the last 5 years. To go further, inflation has been on a downward trend over the last 20 years if you continue to look at the consumer price index (CPI) data (CAN: 2.72% - 1.27% (2000-2020) USA: 3.38% - 0.62% (2000-2020)).

The CPI measures changes in the price level of a weighted average market basket of consumer goods and services purchased by households. The goods in the CPI basket are divided into major categories such as: food, shelter, furnishings, household operations, clothing and footwear, transportation, health and personal care, education and reading, recreation, and food and alcoholic beverages.

By these standards inflation has been on a downward trend and it is mainly due to globalization and the importation of cheaper products from abroad. However, if you look at asset prices, you may come to a different conclusion about the rate of inflation. In recent decades, prices have often climbed much faster for investment assets, such as homes and stocks which have been prone to boom and bust cycles. When interest rates remain low for an extended period of time, it is our belief that inflation shows up significantly for asset prices and actually declines sharply for consumer prices. See below for a comparison between housing prices and inflation over the last 20 years.

In conclusion, one might expect asset inflation to continue to run at a high level indefinitely. Always keep in mind that low interest rates and excessive money printing by central banks lead to asset inflation rather than consumer goods inflation. After all, during a recession or economic downturn, the Fed tends to print more dollars to buy mortgages and stock market assets to support asset inflation. The Fed doesn't print more money to buy consumer goods, therefore there shouldn't be significant upward pressure on those assets.

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