CPI and GDP update

We've been in Maui the past few weeks on our annual family vacation. The island is still recovering from the Lahaina fires 2 years ago (we were there at the time in happened), but there are finally visible signs of rebuilding. Nevertheless, labor is in short supply and prices at the supermarket are sky-high, and to make things worse the island is suffering from a highly unusual dearth of rain, such that the golf courses have been denied water and are slowly turning brown. We were there when the tsunami warning was issued, but it turned out to be a nothing-burger, at least in northwest Maui.

The charts that follow are updates to the CPI and GDP using data that were released in recent weeks.

Chart #1

Chart #2

Chart #1 shows the 6-mo. annualized rate of change in the CPI and the ex-shelter version of the CPI, while Chart #2 shows the year over year change of these two variables. Over the past six months, both measures of the CPI were at or below the Fed's target. I doubt you heard this news in the media, which is anxious to see inflation popping up everywhere thanks to Trump's tariffs. Over the past year, both measures were a tiny bit above the Fed's target. Is that a cause for concern? Hardly. As you can see from both charts, it is the nature of the beast for inflation to wobble above and below 2% on a month-to-month basis.

Chart #3

The thing to remember is that the source of the past several years' inflation is the enormous growth in the M2 money supply. This "extra" money has by now been largely absorbed, thanks to rising prices and tight monetary policy. This is illustrated in Chart #3. With little or no excess money in the economy, there is no reason for inflation to rise on a sustained basis.

Chart #4

Chart #4 shows the 1- and 3-mo. annualized rate of change of Owner's Equivalent Rent. This makes up about one-third of the CPI, and it has for the past two years been the sole reason that the CPI has been above target for the past two years. As I've explained many times, the way the BLS calculates the shelter component of inflation is highly questionable, and almost certainly based on data that is one and two years old—so that it is a very lagging indicator of the true cost of living. In any event, this measure of inflation has been trending down for almost 3 years, and is currently running at a 3.4% annualized rate. It's almost certain to fall further, given that we know that nationwide housing prices—and rents—have been flat to down for the past year and show no signs whatsoever of rising. As OER declines it will become clear to the unenlightened that inflation is behaving as it should.

Chart #4

Chart #4 shows the growth of real GDP over time, plotted on a log scale axis to better illustrate trend rates of growth. The green line is an extension of the trend that prevailed from the 1960s through 2007 (3.1%). The red line is the trend that has prevailed since mid-2009 (2.3%). Actual GDP tends to wobble a bit from its prevailing trend, but not by much. We're still in a 2% growth world, which is unremarkable. I doubt we'll see any significant improvement for awhile, given all the uncertainties surround Trump's tariffs and deportation policies. Eventually we should see some remarkable improvement, as Trump's attacks on taxes and regulatory burdens begin to reap benefits.

We must never lose sight of the enormous gap between where the economy is today and where it might have been if pre-2007 conditions had prevailed. I estimate the gap between the red and blue lines to be roughly $6.4 trillion. In other words, the economy—and incomes—might have been 27% bigger today if policies had been more sensible and less burdensome. Trump has made it clear he wants the economy to return to a 3% growth path, and for the most part his policies support that goal.

UPDATE (8/20/25): For an extended discussion on possible reasons GDP growth downshifted in the wake of the Great Recession (Chart #4), see this collection of my posts on the subject.