New research by a pair of prominent economists suggests that the U.S. economy has been in a recession for the past two years, after inflation adjustments are taken into account.
But inflation figures have been understated by nearly half, resulting in cumulative growth to be “overstated by roughly 15 percent,” economists EJ Antoni and Peter St. Onge said.
Undercounting inflation has implications for economic growth because rapid price changes have bolstered the nominal values of a wide array of economic metrics “without resulting in any real change.”
Antoni and St. Onge cited several data points comparing nominal (non-inflation-adjusted) and real (inflation-adjusted) since January 2019.
New orders for durable goods have increased by 7.5 percent (nominal) but fallen by 13.4 percent (real). Retail sales have rocketed by more than 23 percent (nominal) but rose by 3.2 percent after adjusting for inflation. Nominal disposable personal income has surged by about 35 percent, but the real rate has been just nearly 13 percent.
Nominal gross domestic product (GDP) at a seasonally adjusted annualized rate shows that the national economy has soared by 37.4 percent from the first quarter of 2019 to the second quarter of 2024.
The Bureau of Economic Analysis uses the GDP Price Deflator—a tool that reduces the value of goods and services produced in the wider economy—to reflect inflation revisions. When it is applied, nominal growth declines to 13.7 percent in this five-year span.
But this is flawed, according to Antoni and St. Onge.
“Utilizing a modified GDP deflator that includes more accurate metrics for housing, regulatory costs, and indirect costs yields a more accurate inflation measurement and therefore a more accurate valuation of real GDP,” their paper reads.
Antoni and St. Onge concluded that the adjusted real GDP fell by 2.5 percent from the first quarter of 2019 to the second quarter of 2024, and the United States entered a recession in early 2022.
‘Egregious Biases’ in Inflation Data
The paper aimed to address various “egregious biases in inflation statistics” to gauge an accurate assessment of inflation over the past five years.“This matters not only because of the political salience of rising prices, but also because official inflation numbers are used to calculate real economic growth by adjusting nominal dollars to inflation-adjusted dollars,” the economists wrote.
Antoni and St. Onge noted that government inflation measurements have many shortcomings, from housing to health insurance.
U.S. home prices have accelerated to all-time highs since the start of the COVID-19 pandemic, surpassing rents in the same span.
“The CPI has grossly underestimated housing cost inflation,” Antoni and St. Onge wrote, highlighting that the consumer price index (CPI) fails to “actually account” for the direct cost of homeownership. Instead, federal statisticians rely on the “owners’ equivalent rent of residences,” which accounts for more than 26 percent of the consumer price index.
“If the costs to rent and own change commensurately over time, then this methodology will be relatively accurate,” the economists stated. “Unfortunately, the cost of owning a home has risen much faster than rents over the last four years and the CPI has grossly underestimated housing cost inflation.”
In 1983, the federal government changed its CPI inflation calculations by transitioning from tracking mortgages and housing costs to monitoring “owners’ equivalent rent.” The objective behind the modification was that the measurement would be less volatile, and officials viewed housing as an investment.
Measuring price changes when consumers are not directly charged for services is another challenge to accurately measuring inflation.
Health insurance is one example of this hurdle to correctly assessing inflation.
“Premiums are used both to pay for the actual cost of providing the service of insurance (risk mitigation) and for medical services and commodities,” the report reads. “The CPI neglects both, and instead imputes the cost of health insurance from the profits of health insurers.”
Last month, the health insurance component of the CPI was little changed monthly and rose by 3.3 percent from a year ago.
Quantifying the effects of government regulations can also be a roadblock to better understanding inflation because statistics agencies will determine that prices are lower if products have improved.
Solid Growth, Low Inflation Ahead: Forecasters
The U.S. government recently reported that the economy grew faster than initially reported in 2023.Higher corporate profits, consumer spending, and business investment drove the adjustments.
The first-half recession in 2022 was also canceled as the year’s second-quarter growth rate was revised higher to 0.3 percent from minus 0.4 percent.
Forecasters anticipate strong economic growth and low inflation for the rest of the year.
