Tracking:
Inflation reflects changes in the Consumer Price Index (CPI). The
CPI measures the average price change for a basket of diversified consumer goods
and services within a given period. The specific items included in the basket of goods
changes as consumer purchasing habits change. Example: Are purchases of desk
computers declining, but sales of portable computers increasing? The CPI can be
adjusted to reflect this. It is country-specific, in that the CPI for Finland will probably not
be the same as the United States.
Surveys
The CPI is the responsibility of the Bureau of Labor Statistics,
which relies upon surveys of the spending habits of some 7,000 households. The
surveys are self-reported, and as such are automatically suspect, but the large number
of households provide a significant degree of diversification and are a source of comfort.
Overall, the Principle of Diversification works in surveys as it does in nearly everything
else. It increases the confidence level of the analyzed data.
Those 7,000 households are managed through the Consumer Expenditure Survey. The
expenditures are divided into eight categories and over 200 sub-categories. The largest
bucket, at over 40% of the index, is housing. The other groups are Food and
Beverages, Apparel, Transportation, Medical Care, Recreation, Education and
Communication, and the catch-all Other Goods and Services.
After receipt of the Consumer Expenditure Survey, the BLS assigns economic
assistants to visit or call some 23,000 stores in 87 urban areas from all over the United
States. Additionally, roughly 50,000 landlords and tenants are surveyed. For each
individual item in the index (e.g., cereal) the BLS records prices on hundreds of samples
of the item to assess the direction and degree of price changes, if any.
Inflation can be measured in a variety of ways, and other measures may produce
different results. As reflected by the CPI, inflation is currently estimated at 3.7%. Some
people are skeptical of this finding.
Boskin
In 1995 the Senate Finance Committee appointed the Boskin
Commission to study possible bias in the computation of the Consumer Price Index
(CPI), which is the common way to measure and report inflation in the United States.
The Commission’s final report concluded that the CPI overstated inflation by about 1.1%
per year in 1996 and about 1.3% prior to 1996. The overstatement was caused by a
common response to inflation: product substitution. Example: When beef becomes too
expensive, the purchaser may replace it with chicken. The Boskin Report, in its final
form, provided for adjustments due to product substitution.
Transparency
Note that the Consumer Expenditure Survey, even post-Boskin, had
transparency issues. The raw data used to calculate the CPI is not publicly available, so
outsiders cannot audit the data. This is seen as an important matter because BLS
market data is accumulated too slowly to reflect rapid market changes. Example: During
the Covid lockdown the importance of food far outweighed that of transportation, yet the
CPI continued to weigh transportation more heavily than food.
Alternatives
Some investors find value in inflation indicators other than the Consumer
Price Index (CPI). Fortunately, there are alternatives. If investors prefer not to accept the
government-reported CPI figures at face value, they could instead rely on some other
measure of price changes like the Producer Price Index (PPI), changes in the Gross
Domestic Product (GDP), or the PCE (Personal Consumption Expenditures).
PPI
The Producer Price Index (PPI) measures the domestic output of
raw goods and services and is published monthly. Benefit: may act as an early indicator
for consumer inflation because measurements are taken before producers pass their
production costs on to retailers and thence to consumers.
GDP
The GDP Index measures changes in all the prices of goods and
services produced in the United States. It is published quarterly. Benefit: Includes prices
for more items and thus seems less biased than the CPI. Weakness: Excludes prices of
imports, which are a large part of the domestic economy.
PCE
The PCE includes a wide range of consumer expenses. It is
published monthly and measures changes in consumer goods and services in the U.S.
economy. The PCE uses data from business surveys rather than consumer surveys, as
with the Consumer Expenditure Survey. Of all the measures of consumer price inflation,
the PCE includes the broadest set of goods and services.
- Williams
The economist John Williams (ShadowStats.com) has argued that
CPI numbers have been manipulated for political reasons. He prefers an inflation
measure to be calculated using the original CPI methodology based on the original fixed
basket of goods. Williams, in his calculations, uses the same data collection and
calculation methodologies as the Bureau of Labor Statistics used in the 1980’s to
support the position that headline inflation should be much higher than the CPI reports.
Williams takes the position that the changes in the CPI that were made between 1997
and 1999 reflect a nefarious effort to reduce Social Security outlays. The example
sometimes used is the change urged by Alan Greenspan to incorporate adjustments for
the increased quality of goods sold. The difficulty is in quantifying “increased quality”. Is
the quality of an AM radio enhanced when FM frequencies are added? What if the
buyer never listens to FM?
Indicators to Consider
As a more comprehensive solution to the problem of measuring U.S. inflation, investors
might wish to take an average of the (reported monthly) Producer Price Index (PPI), the
(reported monthly) current Consumer Price Index (CPI), and the (reported quarterly)
gross domestic product (GDP) index. Because these indicators measure different things
(or the same things at different moments in the production process), their relevance
should be considered in view of their fluctuation over time.
References:
https://moneymade.io/learn/inflation-is-higher-than-you-think
https://themessenger.com/opinion/real-inflation-consumer-prices-food-energy-
costs-economy?utm_source=onsite&utm_medium=latest_news
https://www.econlib.org/did-the-boskin-commission-lie-about-inflation/
This article is for informational purposes only and is not intended as professional
advice. Klarise Yahya is not a financial planner. Nothing in this article is
presented as investment guidance. For specific circumstances, please contact an
appropriately licensed professional. Klarise Yahya is a Commercial Mortgage
Broker specializing in difficult-to-place mortgages for any kind of property. If you
are thinking of refinancing or purchasing real estate, perhaps Klarise Yahya can
help. For a complimentary mortgage analysis, please call her at (818) 414-7830
or email [email protected].