Comparing Inflation in the USA and Eurozone: putting things in perspective

Paulus Schuckink Kool 30 June 2022

Inflation has been escalating recently. Numbers not seen since the late ‘70s are published. What do these numbers mean, and how should we put them in perspective? The US’ CPI is not what it used to be, and in the Eurozone HICP is the standard methodology. Inflation numbers are hard to interpret historically and internationally.

In a recent opinion article from FT (Armstrong, 2022), a difference in the causes of inflation in the USA and the eurozone (EZ) was discussed. To summarise the article: the USA is undergoing demand-pull inflation and the eurozone cost-push inflation. Let’s expand on the subject in this article.

Several arguments are used. I will present them with my comments in brackets: - The eurozone is dealing with energy scarcity. (Petrol prices in the US seem to indicate issues too) - Energy prices pass into other prices. (Agreed) - Europe enters the first post-Covid summer. (so is the US) - Consumption in eurozone is still down from 2019Q4, which means that price increases are due imported inflation. (Makes sense in global, well-connected markets) - Labour market slack in the EZ. (The stress at for example airports seems to counter this argument) - Energy and food up because of the war. (Agreed) - ECB tightens because a weaker Euro will increase the costs of imports and cause more inflation. Weakness in the EZ south makes large interest rate increases unlikely. - Mixed signals going forward: bank loans are up (good), bond market is down (bad), Fed will tighten (bad).

To counter the narrative as presented: it seems unlikely that the effects of increasing costs in the eurozone have no spill-over in the USA. Or vice versa, that increased demand in the USA has no spill-over effects in the reverse direction. So, one could argue that both have the same causes: the increased US government spending, supply issues due to the pandemic, and the Russo-Ukrainian war with its resulting sanction packages. Food is doubly affected by the war: a decrease in food and fertiliser exports from the region. Energy supplies need to be rerouted and green policies have led to a decrease of investments in fossil fuels which have impacted supplies. Attributing all extra inflation to the war, the 2 causes, demand after the coronas and the war, cause 5% and 2.5% respectively for the EZ (O'Neill, 2022) (Eurostat, 2022) and 6% and 0.7% for the US (US Inflation Calculator, sd). It can also be observed that the inflation in the EZ lags the US’ inflation. The EZ dependency on Russian imports also explains the larger relative movement.

Historical comparison for the US CPI

In the media it is often reported that we are experiencing the highest inflation since the ‘70s. Inflation was calculated differently in the past though. The New York Times recently wrote an article on this very point. (Smialek, sd) The formula for the US CPI was changed in 1983 by replacing the cost of housing (now seen as an investment instead of consumption) for people who own property by “owners’ equivalent rent” (OER). OER is calculated from data obtained by survey and modelling from actual rental prices (lagged behind spot rental rates: Zillow Observed Rent Index +16% vs CPI shelter component +5%) (Barton, 2022) adjusted for quality and it has about a 25% weight in the US bucket. (Statistics, sd) The impact of this change on the inflation numbers in 1983 was about -1.25%l. Barton (2022) calculated the impact of the change in methodology by applying the original formula; the result was 3.6% higher for February which would have resulted in a CPI of 11.5%. The factors contributing to this difference were rising mortgage rates (+34% yoy) and higher home prices (+20% yoy). Since February mortgage rates are +33% (Lambert, 2022) and the median listing price is +12.5% (Hale, 2022) (17.6% yoy), so it seems reasonable to assume that inflation would have been significantly higher if it was calculated using the old formula. More changes were implemented later. The CPI weighting frequency went from once a decade to biennially. The superlative part was also introduced: it means that consumers may change their purchasing behaviour in response to relative price changes: e.g., buy more chicken if beef is more expensive. The problem with this is that in case of a price increase the substitution must necessarily be providing less utility, and the comparison is therefore inaccurate. The effect of adding the superlative is reducing CPI by around 0.5%. (Smialek, sd)

Comparing US and EZ inflation

The US uses CPI and the EZ uses HICP. These are not calculated in the same way. For example, HICP does not consider the costs of homeownership, which accounts for approximately 15 % of the CPI in the Netherlands (CBS, 2022). There is a plethora of differences in scope, population, price definitions, and classification. Services related to owner-occupied dwellings, contributions to sports and leisure clubs, and consumption-related taxes are excluded from the HICP but are included in the CPI. (CBS, 2022) The population might be different as well: in the Netherlands, CPI includes all consumption by Dutch residents (also foreign expenses), while HICP includes all spending within the Netherlands (including foreign spending in the Netherlands but excluding Dutch expenses abroad). Price definitions can be different too: changes in health insurance coverage will lead to a difference in weighting in the CPI but is treated as a price change in HICP. Lastly, classifications are different in the Eurozone. These differences make comparisons between the US and EZ difficult.

Conclusion

It is difficult to calculate inflation, and institutions make many debatable decisions. The numbers historically and internationally are not calculated in the same manner. This makes comparisons difficult too. If the inflation was calculated as it was in the ‘70s, the US inflation could plausibly be 4% higher than the numbers currently being reported. Or 1.5 times as high as it is now. Puts things into perspective.