Sunday :: Jun 26, 2005

Real Inflation Rate


by soccerdad

I have finally found the answer to a question I have had for some time, i.e. if there is no inflation why is it costing me more to live. Now I knew that certain things were not included in the estimates so I just sort of figured that must be it. I didn’t find it very satisfying but I’m far from an economics expert. But today I have read an article that puts the whole issue into a different light. If the report is correct, then it seems that the government is “cooking the books” to such an extent as to make the inflation reports meaningless. The article is by Jim Puplava and I hope some will read it in its entirety and share your thoughts. It discusses what the “core” rate of inflation is and how it is calculated.

I am just going to give an outline of the major claims. The problem apparently started with the findings of the Boskin Commission in December 1996. Clinton and the Republican Congress implemented many of the recommended changes to the way the inflation was calculated. It was claimed at the time that the CPI was 1.1% too high. The real motivation to lowering the apparent inflation rate was to reduce payments for cosy of living adjustments for the social programs.

Lets look at some of the changes and I’ll illustrate by example where ever possible.
1. Substitution - if the cost of beef rose substitute the price of chicken which hadn’t. When new car prices rose the BLS used car prices were substituted. When real estate prices rose, more weight has been given to the cost of renting which has not increased.
2. Weighting - They went from an arithmetic weighting to a geometric weighting. The effect can be to change completely the interpretation of the data. See the article for a nice graphical example.
3. Hedonics - Thus is my favorite. A real example. A specialist at the BLS decided that when a new 27 TV model came out with new features and still sold for the same price of $329.99 that because of the added value the TV was now worth $194 when entered into the BLS data, However, people had to pay the $329.99.

Hedonics helps the BLS keep rising prices for goods in the CPI from ever showing up as rising prices. Even though the cost of housing, energy, food, medical bills, prescription drugs, tuition, and entertainment have soared, the government keeps reporting moderate inflation. Hedonics is partially responsible. It has become a convenient and subjective way of removing prices increases from the CPI. The combination of substitution, changing the weight of goods rising in price, hedonics and seasonal adjustments is one reason why the CPI and reported inflation has remained as subdued as it is reported each month. The problem is that these numbers are all fictional and bare no resemblance to what households face each month with their actual budgets.

There is an interesting graph that compares the current CPI with that calculated using the pre-Clinton methodology. It shows that although the current CPI is reported to be about 3%, the value calculated using the original methodology is about 6%. During 2002, when inflation was reported to be about 1% the original methodology calculated at 4%.

Does all this really matter? From a day to day perspective - no. We know it has been getting more expensive to live because we pay the bills. But it does illustrate how far the government will go to obfuscate the truth about the economy and implies we can not trust them (no surprise there) to tell us. But what is even more scary is that many in government may actually believe in these numbers and thereby affect their policy decisions. The average person saddled with stagnant wages is actually falling behind at a much faster rate than usually reported. Finally it calls into question comparisons of this business cycle to those which occurred before 1996. I also wonder whether the increasing gap between wages and inflation is a main culprit for the decreased national savings rate.

Finally he goes on to discuss why he thinks there may be a period of hyperinflation coming.

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