Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How Funflation Is Reshaping the Feds Inflation Battle
Transcript
- Lucas: So there's this term floating around the economics headlines right now — 'funflation.' It's a portmanteau, obviously, but it actually captures something real. The idea that the stuff we do to entertain ourselves at home — streaming services, food delivery, gaming subscriptions — is getting more expensive faster than the overall basket of goods. Luna: I've seen that. It feels like every month my Netflix bill goes up a couple bucks, and my DoorDash order is easily 15 percent more than it was last year. But is this a Fed problem? Lucas: That's exactly the question. The Fed cares about inflation in the aggregate — PCE inflation, core PCE, the whole basket. But if 'funflation' is running hotter than the rest of the economy, it might be distorting how we measure consumer welfare. And that matters for policy. Lucas: Let me give you a concrete number. The Bureau of Economic Analysis publishes detailed breakdowns of personal consumption expenditures. For the category 'recreation services at home' — that includes streaming, video games, cable, internet — the price index rose 4.6 percent year-over-year in May 2026. Headline CPI was 3.8 percent. Core CPI, 4.1 percent. So this subcategory is outpacing both. Luna: Four point six versus three point eight — that's not trivial. But is that just a compositional thing? Like, maybe people are spending more on these services because they're staying home more, so the weights in the basket are off? Lucas: You're touching on the substitution bias problem. The CPI basket is fixed — it updates every two years. If consumers shift spending toward at-home entertainment because it's cheaper than going out, but then the prices of those at-home services rise faster, the official CPI might understate the true cost of living. Especially if people aren't actually switching back to going out. Luna: And the data suggests they aren't switching back. The labor force participation rate just hit its lowest level in 50 years outside of COVID — that's from the headline we saw last week. If fewer people are commuting, fewer are eating out, more are home. The consumption pattern might be sticky. Lucas: Right. The participation rate dropped to something like 62.4 percent in June — that's dramatic. And the June payrolls number was just 57,000. So you've got a labor market softening, people giving up on job search, and those people are likely spending more time at home. That reinforces the demand for at-home entertainment, which pushes prices up. Lucas: Now, the Fed's preferred inflation gauge is the PCE price index, which does reweight every quarter. So it handles substitution better than CPI. But even PCE showed core inflation at 2.6 percent year-over-year in May — still above the 2 percent target. And the 10-year breakeven inflation rate just ticked up to 2.24 percent, from 2.23 the week before. Luna: So the bond market is pricing in that inflation stays above target for a while. And if funflation is part of that — sticky at-home spending — it could make the Fed's job harder. They might need to keep rates higher for longer to cool off this particular pocket of demand. Lucas: Exactly. And that's the tension. The Fed is already watching the labor market cool — 57,000 payrolls is not a strong number. The unemployment rate ticked up to 4.2 percent. If they raise rates to fight funflation, they risk further softening the labor market. That's the dual mandate in real time. Luna: But is funflation really a separate thing, or is it just regular inflation concentrated in one sector? I mean, the Fed doesn't target recreation services at home specifically. Lucas: It's not a separate target, no. But it's a useful lens. Because if the substitution bias is causing CPI to understate inflation for a significant chunk of the population — people who are home more, maybe with less income — then the Fed's communication challenge gets harder. They're telling the public inflation is moderating, but households feel it in every subscription bill. Lucas: There's also a measurement issue for the Fed itself. The PCE price index, which they target, uses a chain-weighting method that partially adjusts for substitution. But it's not perfect. If the shift to at-home entertainment is structural — not just a temporary pandemic hangover — then the statistical models might be underestimating the persistence of inflation. Luna: Has the Fed said anything about this? Any speeches or minutes that reference entertainment or streaming costs? Lucas: Not explicitly. The FOMC minutes from the June meeting mentioned 'elevated prices for services' broadly, but they didn't single out at-home recreation. However, a few regional Fed presidents have given speeches noting that the composition of consumer spending has changed since the pandemic, and that this could affect inflation dynamics. It's on their radar, just not front and center. Luna: So what would it take for funflation to actually move the needle at the Fed? Like, what data point would make them say 'we need to talk about this'? Lucas: I think if the core PCE services ex-housing — that's the supercore measure Powell talks about — starts showing a persistent uptick driven by recreation, that would get attention. Supercore has been stuck around 3.5 percent year-over-year for a few months. If funflation is pushing that higher, it becomes a problem. Lucas: But more likely, the Fed would just see it as part of the general stickiness in services inflation. They're not going to micro-target streaming subscriptions. The real value of the funflation concept is that it helps us — and listeners — understand why inflation doesn't feel like it's coming down even when the headline numbers say it is. Luna: Yeah, that disconnect is real. I'm hearing from friends who say they can't believe inflation is only 3.8 percent because their monthly expenses keep going up. And a lot of that is these smaller recurring charges — Netflix, Spotify, Amazon Prime, meal kits. Lucas: That's the lived experience of inflation. And the Fed knows that perception matters. If people expect inflation to stay high because they feel it in their everyday purchases, those expectations can become self-fulfilling. So even if funflation isn't a formal policy variable, it's part of the narrative. Lucas: Speaking of narratives, I want to mention something that keeps these conversations going — and it's a small thing, but it matters. Luna: Go ahead. Lucas: If walking through the economy with us has made something click — maybe you finally understood the substitution bias, or why the Fed watches PCE instead of CPI — a couple of dollars a month is genuinely what keeps these going. Buy me a coffee dot com slash fexingo, if you've gotten something out of them. Luna: Yeah, it's a simple way to support the show and help us keep it ad-free. We really appreciate it. Lucas: Alright. Back to funflation. I want to bring in one more data point. The core PCE price index for May came in at 130.1, up from 129.67 in April. That's a month-over-month increase of about 0.33 percent. Annualized, that's nearly 4 percent. So the trend is still hot. Luna: And the 10-year breakeven at 2.24 suggests the market doesn't see that cooling off anytime soon. Lucas: Right. So the question becomes: is funflation a leading indicator? If at-home entertainment prices are rising faster now, will they spill over into other categories? Or will they eventually moderate as competition increases? Luna: There's some evidence of moderation. Disney+ and Netflix have both introduced ad-supported tiers at lower price points. That could cap price increases in that segment. Lucas: That's a good point. And it's exactly the kind of micro-market dynamic the Fed doesn't model. But it affects the inflation numbers they do use. So when we think about the rate path for the rest of 2026 — with the Fed funds rate at 3.63 percent effective — the Committee is going to be watching these granular trends for signs that inflation is sustainably moving toward 2 percent. Luna: And with participation falling and payrolls weakening, they might have to tolerate above-target inflation for a while longer. The trade-off is getting steeper. Lucas: It is. And funflation is a small but revealing piece of that puzzle. It shows that even when you stay home to save money, the cost of staying home is going up. That's not a reason to panic, but it is a reason to keep watching.