An Urban's Rural View

An Interesting Interest Rate Disconnect

Urban C Lehner
By  Urban C Lehner , Editor Emeritus
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Monthly price increases have come down significantly from when they spiked two years ago, but Americans are still complaining about inflation. And then there's the matter of the uncounted price hike: interest rates. (U.S. Bureau of Labor Statistics chart)

Americans keep telling pollsters inflation is a big problem even as the government's inflation indexes keep showing inflation coming down. There seems to be a disconnect over the definition of inflation.

The Bureau of Labor Statistics' Consumer Price Index and the Bureau of Economic Analysis' Personal Consumption Expenditures index look at the rate of increase in prices, which has indeed come down significantly. The public, however, is talking about price levels, which remain high even though prices are not going up anywhere near as much as they did a couple years ago.

People who want prices to come down should be careful what they wish for. Meaningful plunges in prices tend to happen only when the economy is in deep recession or even depression. In any event, the government can't do much to force prices down.

There is, though, another inflation disconnect, one the government is partly responsible for. Being about interest rates, it's a disconnect of interest to farmers and ranchers.

When Federal Reserve policymakers raise interest rates, they're following a well-tested central-bank inflation-fighting formula. Higher rates slow the economy; in a weaker economy with less demand for goods and services, price increases ease.

What the formula ignores is this: Higher rates make inflation feel worse to folks who borrow money. For borrowers, higher rates are effectively a price increase.

This inflationary effect doesn't show up in the CPI or PCE, which the Fed watches to track inflation. These indexes don't treat interest-rate increases as price increases. To understand why, steel yourself for some economist-think.

Home buyers are one of the largest group of borrowers in the economy and until 1983 mortgage payments, which include an interest component, were part of the CPI. Economists criticized their inclusion, pointing out that the CPI is designed to measure current consumption, not investments. (Buying a home is partly consumption if you're going to live in it but it's also partly an investment; if the price goes up you have a capital gain.)

Responding to the criticism, the Labor Department's Bureau of Labor Statistics adopted what economists considers a purer measure of housing consumption. In 1983 BLS replaced mortgage payments with something called "rental equivalence" -- how much the house would rent for. In 1998, it scratched interest on auto loans. (It does count car prices.)

This is consistent with the way economists view interest. They maintain that it's not like prices of goods and services. Rather than a price of something consumed, they see interest as the price of changing when something is consumed. Instead of saving up for years and only buying a house when you have the full payment in cash, you buy now and pay later. The price of doing that is interest.

However sensible that seems to economists in theory, it's problematic for borrowers in practice. If you have an adjustable-rate mortgage or if you use a credit card and don't pay the balance in full every month or if you borrow from the bank to fund your purchases of seeds and fertilizer, your cost of living or doing business goes up when interest rates rise. It may not qualify as inflation to economists but it sure feels like inflation to you.

Wouldn't it be nice if the government published an index to the broader cost of living, one that included interest rates? Not to replace the CPI but to supplement it.

Between March 2022 and July 2023, the Federal Reserve raised its benchmark interest rate 11 times, from an historic low near zero to the current range between 5.25% and 5.5%, a more than 20-year high. During roughly that time inflation came down from around 9% to around 3%.

For more than a year the Fed has kept rates unchanged, saying it needs more confidence that inflation is moving toward its 2% target before starting to cut rates. Investors are betting the cuts will begin in September with a second cut later in the year.

A broader inflation gauge wouldn't have deterred the Fed from its aggressive increases or caused it to cut earlier. The Fed knows it's pinching borrowers. It hopes they'll stop borrowing or at least have less money to buy other things. Pinching borrowers is how it slows the economy and ultimately inflation down.

But a Cost of Living Index would give Fed and other government policymakers a more nuanced look at how inflation is affecting the public. Devising it would be a small price to pay for trying to reconnect what's now disconnected.

Urban Lehner can be reached at


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