Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘consumer price index’

• An incendiary mix! Inflation, CPI and the U.S. Federal Reserve

Posted by Ron Robins on May 28, 2008

The U.S. Consumer Price Index (CPI) does NOT measure inflation
It is stunning how confusion reigns on the subject of inflation. Simply put: the Consumer Price Index (CPI) does not measure inflation. It tries, imperfectly, to measure the cost-of-living. Inflation and cost-of-living are not the same thing! As elite economists from Nobel Laureate Milton Friedman to the Bank of England’s Mervyn King comment, inflation is a monetary phenomenon. It is evidenced by excessive expansion of the money supply which exceeds economic growth. Therefore, the basis for higher prices in an economy is ‘too much’ money.

One measure of current U.S. broad money supply shows it growing at an annual rate of over 16%! However, there is considerable debate as to what money supply measure best links it with inflation. (I suspect that for developed countries, we might see credit expansion playing a much more important role in understanding the inflationary process than is currently appreciated. But that is for another post to research.)

Most people believe the CPI measures a fixed basket of goods and services over time. That is again, incorrect. It used to be the case, but not anymore. The current CPI basket of goods and services is constantly changing according to what bureaucrats think people are buying, and by numerous statistical alterations they deem ‘appropriate.’

How the U.S. Bureau of Labor Statistics (BLS) modifies the CPI to show tame inflation
The kind of huge modifications the U.S. CPI is subjected to include the following:

  • Substitution of products. Should prices rise, it is inferred people will substitute with something less expensive.
  • ‘Hedonic’ adjustments. If computers’ performance doubles, the relevant index component is halved.
  • Weighting changes of index components. If an item becomes suddenly expensive, it may receive a smaller index weighting.
  • Chain-weighting. Applies to some ‘versions’ of the CPI. This smoothes-out sudden price changes over many months and means indexes using this are always ‘behind-the-curve.’
  • Intervention analysis/seasonal adjustments. Bureaucrats adjust index components according to historical seasonal variations, whether warranted in the current year or not. (See: The Government’s Statistical Whopper of the Year, by Robert P. Murphy.)

Hence, the BLS is able to manipulate the CPI to whatever doctrine holds sway at the time. Prior to about 1980, there actually was a fixed basket of goods and services that comprised the CPI. It did a much better job of measuring inflation caused by monetary expansion. But politicians and some academics did not like this as they said it overstated the actual cost-of-living. For instance, they figured that if beef became expensive, people might buy chicken, and so on, thereby reducing living costs, and thus effectively lowering the index.

Of course, these types of changes also inferred lower living standards. But no politician, or a bureaucracy headed by a political appointee such as the BLS, would want to say that!

CPI inflation over the past year: using 1980’s configuration, nearly 12%; using current methodology, 3.9%!
So around 1980 the CPI began to be massively modified and thus began the trek of divorcing it from monetary inflation. The difference in numbers between the 1980s CPI inflation measure and today’s cost-of-living CPI is extraordinary! John Williams at http://www.shadowstats.com/alternate_data shows that for April 2008, the CPI using 1980s methodology shows inflation over the past year of close to 12%; using CPI (CPI-U) as constructed today it is just 3.9%!

There is no doubt that the ideal of trying to get a consumer price index that reflects the reality of consumer buying behaviour is a good one. But to rely on the current CPI as a means of determining U.S. inflationary pressures so as to modify its monetary policy, is, at first glance, illogical. However, there is something else going-on here.

The Federal Reserve uses current CPI to fool the world in supporting U.S. economy and artificially high bond, stock prices
The U.S. Federal Reserve often cites the CPI as being very influential in shaping its monetary policy. From the foregoing this seems to be a very strange policy. When viewed through a political lens and the need to maintain confidence in the U.S. economy though, it makes sense to try to fool the world at large that inflationary pressures are minimal within its economy.

The U.S. economic problems are so big that if the Federal Reserve and other government agencies came clean on the true rate of inflation, we would see:

  • U.S. economic growth would be shown to have been negative for several years now (real GDP growth rate = nominal growth less inflation)
  • Bond yields would soar
  • Stock market could rise in highly inflationary environment or crash should deflation take-over
  • U.S. government deficit rocket higher
  • Severe economic downtown. Perhaps a depression

As consciousness rises investors everywhere will begin to understand the distinction between U.S. monetary based inflation that is in the double digits, and a highly stylized, theoretical, consumer price index that minimizes the monetary inflationary threat. Prices of everything will then be re-set accordingly.

There is huge danger ahead should the U.S. monetary and credit expansion continue unabated. The excess funds will find their way into more asset classes and lead to further big asset bubbles – and busts. Commodities anyone! Oh, what an incendiary mix!

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© Ron Robins, 2008.

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• The US Consumer Price Index: Let’s Have An Enlightened Approach!

Posted by Ron Robins on December 13, 2007

Update December 14, 2007

Media relentlessly publish the latest government statistics, and markets react to them, sometimes violently. Often your paycheque, government support payments and investment income are significantly influenced by them. But are they valid? Some astute economists and statisticians conclude there is obfuscation of these statistics, and subsequent misrepresentation of them in the media – who usually have neither the time nor expertise to examine them. Take the US ‘consumer price index’ or CPI. These authoritative observers note that the current US CPI incorporates numerous and continuous changes in components and weightings of components within the index, rendering it a mostly theoretical exercise based on highly questionable hypotheses.

According to John Williams (a private New Jersey consulting economist who has specialized in government statistics for several decades), the “Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that.” (The old system, Mr. Williams says, existed prior to the Clinton Administration.)

On his website at http://www.shadowstats.com/cgi-bin/sgs/article/id=343, Mr. Williams states that, “Inflation, as reported by the [US] Consumer Price Index (CPI) is understated by roughly 2.7% per year… due to recent redefinitions of the series as well as to flawed methodologies, particularly adjustments to price measures for quality changes.”

Mr. Williams discusses how the government statisticians include a concept called ‘hedonics’ to adjust values in the index. He states, “Hedonics adjusts the prices of goods for the increased pleasure the consumer derives from them. That new washing machine you bought did not cost you 20% more than it would have cost you last year, because you got an offsetting 20% increase in the pleasure you derive from pushing its new electronic control buttons instead of turning that old noisy dial, according to the BLS [US Bureau of Labor Statistics].”

Williams continues, “When gasoline rises 10 cents per gallon because of a federally mandated gasoline additive, the increased gasoline cost does not contribute to inflation. Instead, the 10 cents is eliminated from the CPI because of the offsetting hedonic thrills the consumer gets from breathing cleaner air. The same principle applies to federally mandated safety features in automobiles. I have not attempted to quantify the effects of questionable quality adjustments to the CPI, but they are substantial.”

The way US housing costs are included is another oddity, keeping that component — at 32% of the CPI — low. Despite two-thirds of the US population living in their own homes, the statisticians use theorized ‘imputed’ home rents as the basis for the housing statistic! Of course rents have been virtually stagnant for years — even going down in many cities due to overbuilding — while home purchase prices, insurance and local taxes, etc., have been going through the roof!

For those Americans dependent on CPI adjustments to their welfare, social security or other government payments, they have had their payments massively depressed. Williams says that US government welfare and social security payments are now 70% lower than what they would have been had the old 1970s style CPI been used with its fixed basket of goods.

Another astute statistician, Jim Willie, elaborates further on this point. In Domino Distortions from Inflation, an article on his website at http://www.goldenjackass.com/jwarticles.html, he comments, “In my view, the [US] CPI has become little more than a measure intended to exploit the trend of falling imported finished product prices, in order to keep cost of living raises down in US Government pensions of various types…The CPI is kept low by ignoring numerous rising prices, such as property taxes, town usage fees (water, sewer, sanitation), professional services (doctor, dental, lawyer), home services (carpentry, plumbing, electrical, roofing), college tuition, restaurant meals, sports club fees, and more.”

The US CPI affects not only Americans, but consumers and investors everywhere. US domestic and global interest rates, bond yields, and returns from many other investments — all are significantly influenced by it.

It is worth remembering that the BLS is headed by a political appointee, who just may have certain biases towards statistical methodologies that most please the government — as well as to what gets out to the media.

Reviewing the December 2007 charts on Mr. Williams’ website, we can easily see the startling differences in outcomes with the varying CPI methodologies used over the past thirty years. Using the CPI methodology as it was in 1980 shows inflation today rising +12% year-over-year; employing the CPI methodology as of 1990 shows inflation higher now by +7.5%. However, today’s BLS press release has their CPI-U (urban dwellers) gaining just +4.3% over the past year!

Is the current US government reported CPI presented to play down inflation, to artificially reduce interest rates, social secuurity payments, and government payouts dependent on CPI indexing? I believe so. And it is simply unethical. As the public begins to see through these deceptions, an enlightened economics can begin to truly flourish!

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© Ron Robins, 2007.

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