Inflation Controversy

In my first post in this series I talked about inflation figures as they are calculated by the Bureau of Labor Statistics. Today I’ll discuss some of the criticisms of this statistic and why it might actually be higher than what is being reported.

A cursory analysis of the information-gathering methods described by the Bureau of Labor Statistics certainly raises some questions regarding the accuracy of inflation figures. Any type of survey can introduce sampling errors, and it’s important for the surveyor to accurately quantify that sampling error, which the BLS does provide. However, this is nothing new within the general area of statistics, as CPI detractors focus more on the non-sampling errors. These errors include (according to the BLS) “logistical lags…difficulties in defining basic concepts and their operational implementation, and difficulties in handling the problems of quality change”. These are real issues that, if improperly managed, can have a significant impact on the final CPI values, and consequently, the inflation rate. The BLS attempts to manage these potential areas by periodically reviewing their price calculation and CPI weighting algorithms, as well as relying on their commodity experts who are responsible for making sense out of the figures the field analysts return. Regardless, questions have been raised by many economists about the validity of these values.

In this post I’ll discuss two main areas that critics have focused on: whether the 80,000 item index represents an impact felt by a “typical” family and how the BLS takes in account changes in the goods and services.

Having over 80,000 items in the index has its advantages and disadvantages. As far as the advantages are concerned, by having such a large index, you’re tracking most of the items purchased by American consumers. This will enable high granularity information on the costs of running a household. Pretty much anything you could think of purchasing is on the list. However, that fact doubles as a disadvantage, as the entire index is too extensive to act as a strong indicator of how the impact of inflation is felt by you as an individual. The BLS admits as much on their website, stating: “It is unlikely that your experience will correspond precisely with either the national indexes or the indexes for specific cities or regions”. Since the indexes are based on the average household experience, there will be goods and services used that are not representative of your experience.

Others have attempted to compensate for this deficiency by examining the CPI and eliminating non-essential items, or by focusing solely on major categories that are of high importance or are monitored closely. For example, housing is an area that garners a lot of attention. By focusing a specific index of the fluctuations in the housing market (and identifying differences between renting and owning, for example) you’re able to gain a clearer understanding on the housing statistics, numbers that could be washed out in the overall average. The U.K. for example publishes the same figures as the U.S. However, London’s The Independent compiles their own inflation figures relying on what they’ve identified as “core” goods and services. Their figure is often as much as twice as high as the government-released data.

Changes in goods and services present an interesting problem for the BLS. If, for example, a 2003 Buick costs the same as a 2009 Buick (same model) are they equivalent products? Obviously not, as the newer model contains improvements that increase its intrinsic value (better safety equipment, more efficient engine, etc…). If the 2009 model is $5,000 more, does that $5,000 properly represent the increase in value of the new model? So how does the BLS commodities experts quantify those differences? That is where they rely on the expertise of their economists, to make judgment calls (based on their experience and historical data) that affect how those figures are calculated. The same goes for things like technology. How much more worth is contained within an iPhone 3GS than the first generation iPhone? That is a very difficult thing to quantify.

Ultimately the issue of inflation is drawn back to income. If your income increases at a rate greater than the rate of inflation, then you are ok; you’re building wealth (assuming you buy the same goods and services every year). If you receive a raise that is less than the rate of inflation, then your paycheck might be larger, but you’re purchasing power is lower. While you might not necessarily be able to make a one-to-one comparison between government-released inflation figures and your own experience, it’s still a good figure for examining the health of the economy as a whole.

Michael
Twitter: @michael_dink