Is the US government wildly understating the inflation rate? No, it isn’t

AEI ^ | January 17, 2013 | James Pethokoukis

[1rudeboy]

It’s hard to find much inflation in the US economy right now. As measured by the Labor Department’s consumer price index, prices increased by just 1.7% in 2012. The core CPI, which excludes food and energy prices, rose by 1.9%.

Nor can much inflation be found in an alternate measure, the Commerce Department’s personal consumption expenditures prices index. It rose 1.45% for the twelve months ending last September. Excluding food and energy, it rose 1.58%. Federal Reserve Chairman Ben Bernanke prefers the PCE price index because he believes it better reflects changes in consumer purchasing habits.

But some skeptics say those government-generated statistics are nonsense. The numbers are skewed — perhaps intentionally — to show inflation much lower than what it really is. Instead of 1% to 2% annual inflation, prices have actually been rising at 10% a year, maybe even faster.

Now, extraordinary claims should require extraordinary evidence. So the burden is on the inflation hawks here. As it is, the Labor Department has specifically and thoroughly rebutted many of the criticisms of the CPI, including charges that when the price of steak rises, the Bureau of Labor Statistics swaps it out for cheaper hamburger. Or that Social Security payments are indexed to a CPI measure that doesn’t include food or energy.

In particular, critics question how the BLS currently a) assumes consumers will purchase the cheaper of two types of products, and b) takes into account, for instance, that a $1,000 computer today is a whole lot more powerful than one 15 years ago. Those are just two of the modifications the BLS has made over the years in how it measures inflation.

But what if BLS still calculated inflation the way it used to back in the 1970s? The agency studied that exact question in 1999, and found the new approach gives only a modestly lower inflation reading:

Over the 21-year period of the study (December 1977 to December 1998), the CPI-U-RS increased 141.2 percent, compared with 163.9 percent for the CPI-U. The figures represent an average annual increase of 4.28 percent for the CPI-U-RS and 4.73 percent for the CPI-U; the average annualized difference between the two measures is thus 0.45 percent.

In fact, there’s considerable academic literature suggesting that Washington continues to overstate inflation rather than understate it, such as this paper by Robert Gordon of Northwestern University:

This paper provides a retrospective on the 1996 Boskin Commission Report, Toward a More Accurate Measure of the Cost of Living, and its famous estimate that the CPI in 1995-96 was upward biased by 1.1 percent per year.  …  This retrospective evaluation suggests that the Boskin bias estimate for 1995-96 should have been 1.2 to 1.3 percent, not 1.1 percent. Current upward bias in the CPI is estimated to have declined from the revised 1.2-1.3 percent in the Boskin era to about 0.8 percent today. Yet the Boskin report, like most contemporary studies of quality change, failed to place sufficient value on the value of new products and on increased longevity. Allowing for these, today’s bias is at least 1.0 percent per year or perhaps even higher.

One final reality check — especially clarifying if you believe Washington is intentionally cooking the books — is MIT’s Billion Prices Project, which uses an algorithm to track prices online, including most of the products and prices found in the CPI. It has inflation running at less than 2% over the past year:

Now, inflation might well be far higher in the future than it is today. And of course, the inflation rate experienced by any one individual may differ, perhaps considerably, from a broad national index. But inflation overall, much less hyperinflation, isn’t a big problem right now.

[1rudeboy]

It should be important to consider that, according to this blog, the Weimar Republic went from "normalcy" to hyperinflation in the space of three months. But that "fact" does not absolve a rational observer of economics of claiming that hyperinflation is here, now (like those bozos over at Shadowstats.com).

[1rudeboy]

I thought I’d give the hornet’s nest a good whack.

[Opinionated Blowhard]

All I know is that my grocery bill has gone way up over the past few years. And even for items that have not gone up, the amount in the bag or box is less. You open the bag and 2/3rds of it is empty. My utility bill has gone up about 10% too. I guess if I ate less and drove less and sat around in the dark, my bills would be lower and I wouldn’t be contributing to inflation.

[central_va]

Inflation is not a problem unless you have to send you son or daughter to college, or buy insurance of any kind, buy food or gasoline. < sarc > So if you are a self sufficient farmer with no kids, forgo health insurance and have your own supply of methanol that you produce yourself then there is very little inflation< /sarc >

[1rudeboy]

The government also takes into account shrinking package sizes when calculating inflation. So if your 36oz. can of coffee shrinks to 34oz., with the price remaining the same, it counts as price inflation.

[1rudeboy]

College tuition has been rising at a much higher pace than inflation for decades. Gasoline prices are down (significantly) since this summer.

[marstegreg]

“Excluding food and energy, it rose 1.58%”

Of course food and enegy were not included!

[Dave346]

See this CNBC article from April 2011:

Inflation Actually Near 10% Using Older Measure

http://www.cnbc.com/id/42551209

[dirtboy]

As someone who shops very cheaply for groceries, I can attest that low-end prices have risen signficantly over the last 3 years or so. Used to be you could find chicken legs for 49 cents a pound at times, now the cheapest you see are 79 cents. Potatoes? Used to be able to commonly find them for 99 cents for a five-pound bag, the last time I saw them at the price the spuds were very poor quality. Fair quality spuds are 1.49 a bag cheapest now. Store-brand tub margarine? Gone from 1.99 to 2.99.

Other examples abound. Those are significant percentage increases for someone on a very tight food budget.

And this is why a lot of people question the official inflation stats - their own eyes are telling them something very different.

[blueunicorn6]

The price for a gallon of gas is coming down. This has nothing to do with Obama, but he’ll sure take credit for the results. Those dirty oil companies may actually wind up saving us. I think a lot of the trouble in the Middle East stems from OPEC looking at our new found energy reserves and realizing that the golden days are coming to an end.

[1rudeboy]

Of course food and enegy were not included!

Except, of course, when they were included. The author takes care of that canard by including both figures (included and not included).

[garbanzo]

A study in 1999? Those graphs appear to be diverging and it’s over 13 year old data. What are the differences between the old style inflation calcs and the new style ones today?

[Longbow1969]

But that "fact" does not absolve a rational observer of economics of claiming that hyperinflation is here, now (like those bozos over at Shadowstats.com).

You get a lot of this stuff on ZeroHedge and elsewhere too. There is an "end is near" crowd of economic bears that instinctively try to paint the worst picture possible at all times. Things are bad enough as it is, there is no need for exaggeration. If you believed the bulk of opinion on ZH, gold should be worth triple what it is now, the EU should have been broken up already and Americans should be rioting in the streets over hyper inflation. Instead Wall Street has run up nicely over the last couple years and anyone who invested wisely did pretty darn well.

It is certainly true that the economy and markets are not healthy (and may well be a house of cards that could implode in the future), but that doesn't mean they will collapse tomorrow, or that hyperinflation will occur in the near term, or that we won't have some good growth quarters, or that there isn't a ton of money to be made.

[1rudeboy]

Interesting comment I saw once about Shadowstats . . . by the time an actual economist crunches, and then refutes its numbers, it’s gone and reposted its BS a dozen more times.

[Born to Conserve]

This guy is an idiot.

[dirtboy]

About that graph from 1978 to 1999. Notice the gap between the old method and new method grows every year, basically doubling every 10. So a gap of 20 points in 1999 would become a gap of 40 points by 2009 and close to 50 by now. Basically, it is gradual negative compounding of the CPI, which was, IMO, the intention all along of the changes.

[1rudeboy]

Agree. And certainly worthy of more study. The question is, is the divergence as large as the folks who want you to buy their newsletters (or sell you gold) claim?

[Varsity Flight]

“Excluding food and energy”

And there you have it.

and further, meaningless without tracking the employment numbers , and the skyrocketing foodstamp numbers.

and further, behavioral conditioning have many to believe gas prices above 1.00, yes ONE dollar, are “low.”

Massive numbers of government paychecks = price pressures

[Uncle Miltie]

HOUSING!

“Owners Equivalent Rent” is the basis used in inflation metrics for the cost of your housing.

Since the value of houses has been collapsing, the biggest thing you spend money on, housing, has been rapidly declining within the basket of goods the Fed considers.

Therefore, inflation everywhere else can (possibly) be hidden by the rapidly declining value / cost of houses.

Now, did you really experience a reduction in cash outflow because your house declined in value? No?

So, is the Fed really just using a housing bust that killed your Net Worth as a cover for actual inflation everywhere else in the economy?

Quite possibly.

Who will go do the analysis of “Inflation, excluding Housing”?

[dirtboy]

The truth, as always, is somewhere in the middle. I’ve been around long enough to have a jar of very large grains of salt for reading the rants from the doom-and-gloom crowd. Problem is, we almost did melt down a few years ago, and I have seen little done to address the root causes of that meltdown - in fact, in some areas it is even worse, as Dodd-Frank has instutionalized too big to fail, just for one example. So if nothing positive is done, one of these days the gloomers will probably be right again, albeit probably for the wrong reasons.