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Guest Post: Why Reported Inflation Seems Different Than Reality
Via Lance Roberts of StreetTalkLive,
The subject of inflation has remained an emotionally charged topic of debate over the last several years. As rising prices for individuals, and businesses, has negatively impacted their prosperity; reported inflation has remained at very low levels. With the Fed pumping trillions of dollars into financial system the fear of much higher inflation, as the dollar is debased, has caused gold prices to soar in recent years. As we will discuss momentarily, the issues surrounding government spending, and the massive deficit, has brought the topic of inflation to the forefront of the political debate.
However, a bit of history is needed for context. The government produces a measure of inflation called the consumer price index (CPI) which is generally broken down into two reports: Headline and Core. The only difference between the two measures is that the core reading strips out the volatile food and energy components. It is this core reading that economists, and the Fed, focus on much to the aggravation of average consumers who quickly point to the fact the food and energy are big part of their daily lives.
The sole purpose in measuring inflation is to help businesses, individuals and government adjust their financial planning for the impact of inflation. Inflation erodes future purchasing power, and decreases economic prosperity, if not accurately accounted for. The accuracy of measuring inflation, and accounting for it properly, is essential to long term economic prosperity.
The original calculation of CPI, which measured the change in the cost of an identical fixed basket of goods priced at prevailing market costs each period, worked reasonably well for the intended purpose into the early-1980’s. However, as the pressure of increasing deficits weighed on political parties, the need to find solutions to reducing spending, without actually cutting spending, led to several substantial changes in the calculation of inflation.
Shortly after Clinton entered the White House the Bureau of Labor Statistics (BLS) altered the calculation of inflation by changing the weighting of goods in the CPI fixed basket. Then, over subsequent years, the method of weighting the underlying components was changed from a straight arithmetic weighting method to geometric. The primary result of the switch to a geometric weighting was a lower weighting to CPI components that were rising in price, and a higher weighting to those items dropping in price which led to lower reported inflation.
According to John Williams:
“…the net effect was to reduce reported CPI on an annual, or year-over-year basis, by 2.7% from what it would have been based on the traditional weighting methodology. The results have been dramatic. The compounding effect since the early-1990s has reduced annual cost of living adjustments in social security by more than a third.”
But the manipulation of the data did not stop there. Aside from the weighting changes the BLS instituted a system of “hedonic” adjustments. 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.
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.”
Lastly, there is "intervention analysis" in the seasonal adjustment process. Intervention analysis is critical to the highly volatile areas of food and energy. When a commodity, like gasoline, goes through periods of violent price swings the BLS steps in and uses “intervention analysis” to smooth out the volatility. As a result, sharply rising gasoline prices are never fully reflected in the reported headline inflation number. However, declining prices, which are never adjusted, do show an impact to reducing inflation.
The obvious problem with these manipulations is it changed the measure of inflation from a cost-of-living adjustment to a reduction-of-living adjustment. The original CPI calculation allowed individuals to understand the rate of return required on investments and incomes to maintain their current standard of living. However, by artificially suppressing the rate of inflation, the future standard of living is reduced to lower levels.
The chart above shows the original calculation of inflation (which was based on a basket of goods), data sourced from John Williams, versus the current measure of CPI. It is quite apparent that inflation, as reported by the Consumer Price Index (CPI), is understated by roughly 7% per year.
The deviation between the two measures is strictly due to the redefinitions of the series and adjustments to price measures utilized. These changes to the CPI have detached the cost-of-living adjustments from the real cost-of-living experienced by those dependent upon a fixed income stream for survival.
According to John Williams:
"In particular, changes made in CPI methodology during the Clinton Administration understated inflation significantly, and, through a cumulative effect with earlier changes that began in the late-Carter and early Reagan Administrations have reduced current social security payments by roughly half from where they would have been otherwise. That means Social Security checks today would be about double had the various changes not been made. In like manner, anyone involved in commerce, who relies on receiving payments adjusted for the CPI, has been similarly damaged. On the other side, if you are making payments based on the CPI (i.e., the federal government), you are making out like a bandit."
This is why the average American has repeatedly lashed out at the current measure of inflation as it doesn't represent the inflation rate that they are personally experiencing. Rising food and energy costs are consuming more and more of a declining level of incomes. For those individuals dependent on a fixed stream of welfare payments the lower rate of inflation adjustments, while putting more money in the coffers of the government, has led to a steadily declining standard of living for the elderly.
The Chained CPI “Fiscal Cliff” Farce
In the latest attempt to save the economy from the "fiscal cliff" a grand bargain is being crafted that will possibly include a relic from the debt ceiling debate in 2011 called "Chained CPI." As with the Clinton Administration, once again the need to reduce government spending has given rise to a proposal to further suppress the measure of inflation to reduce the cost of living adjustments for social security recipients. The issue with "Chained CPI,” as with the current measure of CPI, is that it will further misrepresent what the average consumer is living with from day to day.
The Washington Post stated:
“Economics and policymakers generally make the assumption that when prices rise, people will turn to a less expensive product. They’ll buy chicken instead of more expensive beef, iceberg lettuce instead of arugula, store-brand, instead of name-brand cereal. The chained CPI attempts to account for how people react to inflated prices.
It’s an arcane detail in the ongoing budget debate, but the chained CPI is appealing to budget experts and some Republicans and Democrats, because it only slightly tweaks the inflation formula, while building significant savings over time, perhaps more than $100 billion over a decade.
Making such a change also means paying out less in Social Security benefits over time — something liberal Democrats can’t stomach. Imagine, for example, a person born in 1935 who retired to full benefits at age 65 in 2000. People in that position had an average initial monthly benefit of $1,435, or $17,220 a year, according to the Social Security Administration. Under the cost-of-living-adjustment formula and 2012 inflation, that benefit would be up to $1,986 a month in 2013, or $23,832 a year. But if payouts were adjusted using chained CPI, the sum would be around $1,880 a month, or $22,560 a year — a cut of more than 5 percent and more as the years go by.”
When it is known in advance that tweaking the math will create a "permanent" reduction in the measure of inflation then it is no longer an accurate assessment of inflationary pressures in the economy. If adopted across the government, the change would have far-reaching effects on the many programs that are adjusted each year based on year-to-year changes in consumer prices.
The groundswell of aging “boomers” that will are rapidly approaching the point of become welfare program recipients will find that the fixed stream of income payments will not be sufficient to maintain their current standard of living in the future. This will continue to push an ever aging population into working much longer into their retirement years.
Furthermore, a side effect of artificially suppressing inflation is that taxes would slowly increase because annual adjustments to income tax brackets would be smaller. This would eventually push more people into higher tax brackets allowing fewer people to be eligible for anti-poverty programs like Medicaid, food stamps and school lunches. While the annual adjustments will eventually remove individuals from poverty on a statistical basis – it doesn’t mean that would be any more capable of supporting themselves.
Lastly, one reason why there has been such a disconnect between reported GDP, and the way that average Americans feel about the economy, is due to the way CPI affects the GDP calculation. Although the CPI is not used in the actual GDP calculation, there are relationships with the price deflators used in converting GDP data and growth to inflation-adjusted numbers. The more inflation is understated, the higher the inflation-adjusted rate of GDP growth that gets reported. The problem is that real inflationary pricing pressures is simultaneously eroding the real prosperity of the average consumer.
While going to "Chained CPI" will save the government over $100 billion during the next decade in payments to individuals - this is not a good thing for those dependent upon those payments. Furthermore, the assumptions for budgeting will also be grossly flawed which means that when we get to the end of this decade it is likely that we will be in worse shape than was estimated. Hopefully, those in Congress will opt not to further suppress the inflation calculation for political gain at the expense of the average American.
In the coming weeks ahead, in collaboration with my friend Doug Short, we will be introducing an inflation index which will be reconstructed along the same lines as the original form of CPI using an arithmetically weighted calculation on a fixed basket of goods. It is hoped that from this experiment we can establish a baseline from which we may be able to ascertain the actual impact of the current environment on incomes, spending and the economy. Stay tuned.
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Just like Biden said - They're gonna put ya'll back in chains
Yahweh detests differing weights, and dishonest scales do not please him.
Yep, oldest trick in the book. But the times they are a changin'
Shame on politicians. The CPI should truthfully be reported. Tweaking it is in essense stealing from retirees. The CPI should be measured withi something similar to the MIT "billion price" project.
The drones will continue their 9-5 slavery until the fat lady sings.... game over. At what point do you realize the game is rigged people.
Great article confirming what we all think and now know. Note that this game continues until it becomes really embarrassing to defend at which point the government just decrees that it won't be issuing a CPI number anymore. This is where we are headed...ratings agencies, unemployment and inflation are all fine, truly feels more and more like the Matrix every day.
"The sole purpose in mis-measuring inflation is to fool businesses, individuals and government into mis-adjusting their financial planning for the impact of inflation."
Fixed it for ya. :)
Good to know you are still around pontificating.
I invoked your name yesterday in explaining society's non reaction to this fiscal mess to my son.
Happy holidays and I expect more missives from you in the new year.
Take care
Additional information is available from John Williams at www.shadowstats.com
Your avatar rocks.
When they reincarnate the Federal Reserve, after the Mr. Creosote-like explosion from all the toxic debt it's intentionally gorging on, do you think they'll change the name to The Bank of Prosperity For The American People, or something even more catchy?
The Roman Empire probably only made it 500+ years because clipping coins was the technology of the day [together with the abacus]...
~~~
Modern technology will actually hasten the demise of the latest & 'CIVIL'[cough cough]-ization du jour...
"People in that position had an average initial monthly benefit of $1,435, or $17,220 a year, according to the Social Security Administration. "
Horribly deceptive.
The average Soc Sec recipient gets $1230/mo or $14760/yr. They cherry picked that number to make it look livable. You get into median and average stuff, but in general nearly half of retirees are below $14.7K/yr. Think you can live on that?
The most common retirement income level is between $15,000 and $19,999 annually, an income range that 12.6 percent of retirees fall into.
For 36% of retirees, SS represents over 90% of total income. For over 50% of retirees, SS represents over 60% of income. How do you cut that and have them not die?
Depending where you are in the country, that can be totally livable... especially when considering it is SUPPLEMENTAL income... and is aided by numerous other governmental benefits that may not show up as "income" but that none-the-less provide significant benefit.
I think a means test would be more palatable than a whack across the top to all, but I'm not the policy maker...
Cat food.
Dry, generic cat food.
Dead cats.
His example was for the average of people retiring at age 65 in the 2000, not for the average of all SS recipients.
CPI also figures into the COLA increases for programs like social security; it's in the government's interest to under-report inflation so they can under pay retirees long enough so that the old people have to choose between food and medical care and die off sooner. Then the feds have even LESS to pay out in the long run...
Great article.
Furthermore, a side effect of artificially suppressing inflation is that taxes would slowly increase because annual adjustments to income tax brackets would be smaller. This would eventually push more people into higher tax brackets allowing fewer people to be eligible for anti-poverty programs like Medicaid, food stamps and school lunches.
Since when do tax brackets adjust for inflation? The AMT certainly doesn't. I don't think we have to worry about entitlement shrinkage either...due to inflation or anything else - if only!
I see the above chart but does anyone know where/how you can find or back into (with the actual components) the old-school CPI using current inputs?
Update: Of course, duh. http://www.shadowstats.com/
Naahh. People making 12k a year will never get that far.
BTW, where is the talk of ALL MILITARY AND US CIVIL SERVICE PENSIONS ALSO BEING CUT LIKE THIS? Are they seriously going to just do Soc. Sec?
What about Congressional and President and Judge pension COLAs?
Oh, so they don't just lie?
Wife came back from the store this morning and said: "Do you know what White House Apple Sauce is up to ?..........$1.53 A CAN !"
Last time she bought some, it was in the 50 cent/can range......and was 4 cans/$1 for years and years.
Nah....there isn't any inflation.......
I thought this was a lead-in to a joke...
Oh!.... "Ping Pong Balls"!... I thought you said "King Kongs Balls"!!!.....
No...not only is there no inflation...but thanks to the chained CPI calculation, you can replace the apple sauce with, say, a $0.10 banana...and voila....deflation.
Both are fruits, game theory. Like Timmy and Ben, interchangeable fruits.
Whoa REALLY? You mean it's ALL just fake numbers and I'm not supposed to notice real inflation like a quart of Mobil1 was around $4 a few years ago and now is $10?
'No inflation' my ass.
The economists figure you can replace Mobil1 with Snake Oil...lots of that is available these days.
Boskin Commission
you get the government you can afford
Reality is that which continues to exist, even after you stop believing in it. --Philip K Dick
#41
One thing Milton Frieman got right:
Inflation is always and everywhere a monetary phenomenon.
Inflation isn't "price changes." It's what happens when money is created out of thin air. If people take that money and stuff it in their mattress (or 401k, for that matter), that money has no effect on prices UNTIL people actually start spending it
The dollars have already been created. It's when everybody notices prices are rising and reaches for their giant pile-o-paper to get stuff simultaneously that there's a problem. You can't spend the paper fast enough.
Savings? Worthless in no time flat.
Investments? You'll need to cash them out for food. As will everybody else (in other words, collapse)
Financing? Gone
The idiots who say inflation is low don't understand what inflation is. They're the same people who wander onto the beach just before a tsunami hits going, "Check it out, the ocean is GONE!"
It'll be back...
Why reported 'everything' is different from reality?
Yes they are yanking our chains.
>>>In the coming weeks ahead, in collaboration with my friend Doug Short, we will be introducing an inflation index which will be reconstructed along the same lines as the original form of CPI using an arithmetically weighted calculation on a fixed basket of goods.<<<
Thank you very much.
John Williams @ shadowstats already does that.
As do I and for quite a while:
http://www.nowandfutures.com/cpi_issues.html
Issues with CPI-U accuracy.
The simplest evidence that CPI substantially understates inflation is the decrease in standard of living and purchasing power of seniors who have lived for a few years with their total income only based on Social Security payments.
The medical cost component of CPI-U is about 7% of its total. GDP medical costs are about 17% of total GDP. Medical inflation is amongst the highest of all CPI components. Since CPI-U medical share is substantially understated as a percent share of total CPI-U, it causes significant understatement of inflation. Consumers pay for all medical care, sometimes indirectly via taxes (which is also not in the CPI, even in memo form), etc.
Hedonic adjustments (accounting for quality and feature etc. increases) are made in the CPI, but no reverse hedonic adjustments (accounting for quality and feature etc. decreases) are made. Failing to account for the many things like smaller airline seats or 'plastic' dining room tables causes CPI to be understated.
Geometric weighting and substitution bias adjustments in the CPI do things like increase the weight of chicken prices when beef prices go up. Although people do tend to buy more chicken when beef prices go up, it's also a decrease in the standard of living - which again understates actual inflation. An accurate cost of living or inflation index should not contain adjustments which involve a lower standard of living.
The CPI Owners Equivalent Rent (OER) calculation has done a poor job of tracking real housing costs when compared to housing indexes like Case Shiller, thereby understating inflation especially during the housing bubble.
Health insurance costs have only been tracked in CPI since 2005, but it has understated actual costs quite substantially when compared to government CMS and private industry Kaiser health insurance cost data.
No actual facts about specifics of actual prices and price adjustments are available from the BLS. The raw data is just plain unavailable and it is a closed system, preventing anyone from confirming or denying CPI accuracy. The Federal Reserve is actually way more open.
Taxes are not included in CPI. How can a price index that states it measures actual inflation not count taxes (even in memo form), which have been as high as 33% of income since 1913? Taxes have a price and are paid by consumers.
How do you account for comparisons when technology changes. For example, the price of a TV. How do I compare a TV I bought in 1997 with the TV I bought in 2011?
Hedonics would suggest that the 1997 TV cost $200. The 2012 TV is priced at $400 today but actually costs the same after $200 worth of benefits are removed that you didn't have before. Deduct HD technology, flat screen, LCD, etc. Hence, the price for today's TV has gone down exponentially.
You can see these numebers can be whatever you want them to be. How do you price value HD vs. standard definion? It's a guestimate.
Through their hedonics massage! Today's TV's are so much better than those in 1997 so that will knock the inflation figure into negative areas!
The trouble is, I can't buy that 1997-featured TV at what should be the reduced price hedonics assigns to it.
Another example - computers/smartphones. Now they are twice as fast, at the same price more or less. So, according to hedonics, they've gone down 50%. But I can't buy that half-speed one for half the price - it's not available on the shelves. I have to buy half as many new ones to get the same effect.
Try that with your office cubicles - you now get to share a computer/smartphone instead of having one for each person, and see if productivity stays the same... Yeah, right.
No inflation measure is going to get it right anyway. I'm at a kind of strange point in life where most of what I buy is just plain food, plus a bit of energy (but I'm off grid solar, electric car, so not much energy). Little to no health expense (yet, but I ain't getting any younger). No debt. Paid off home - so using home prices (dropping) in CPI to cancel other things going up is bogus, totally, it doesn't help me - I'm not in the market, and should I want to sell, I get less!
Now, a neighbor spends most of what they get on health care. Which is going up faster than anything else.
While someone just starting out is buying all manner of things - furniture, silverware (hope it's really silver), other kitchen stuff, appliances, and so on.
Obviously, no one measure of costs covers all 3 cases, no matter what you do.
This doesn't let the government off for cooking the books to keep COLA's down, however.
Your right of course, every consumer is different. "CPI" will only make sense in a totally planned economy where every consumer is the same because there is only one thing on the shelf to purchase. Maybe they're just ahead of themselves with the metric.
Cat food for everyone. Look, the CPI went down!
Forward!
They both spew(ed) propaganda... In that way they are the same...
So artificial inflation metcics is a farce meant to decrase government spending behind a curtain of lies.
Proof that the only spending to be cut is the spending yet to occur and the spending that they don't have to admit to cutting.
If you can't see it it's not there magic tricks.
“Economics and policymakers generally make the assumption that when prices rise, people will turn to a less expensive product. They’ll buy chicken instead of more expensive beef, iceberg lettuce instead of arugula, store-brand, instead of name-brand cereal. The chained CPI attempts to account for how people react to inflated prices.
Ahhhh, I see. So next when the price of chicken goes higher I'll buy the expensive canned gourmet dog food before I resort to the cheap kibble?
How's that shit taste?
Not bad, actually. Made chili in college out of Cadillac-brand dog food. It was a.... um.... "joke" we were playing on somebody. He ate the bowl clean while we could barely keep from laughing. Asked him how it was and he said it was "awesome." We could have fed it to him all semester and he wouldn't have known.
Cat food is even better, I'm told. Almost like people food.
That's one data set the crooks and invading forces use to take over this country. Bitcoin is an answer.
He ain't kidding.
My EBT card only gets me half as many lobsters as it did before.
And the bitches make me boil them myself.
And in conclusion, stop believing your lying eyes.
Fear not...
Reported by Dr. Lauren Browne:
The first crunchy bite of an inch-long fried grasshopper in a chapulines taco is surprisingly palatable. The reddish-brown bug is coated in Oaxacan-style spices that pepper the tongue and enhance the underlying nutty, earthy flavor of the grasshopper itself. Admittedly, the most difficult part of eating the bug is taking that first bite.
"It isn't as much an assault on the senses as it is an assault on the mind," said Dan Childs, managing editor of the ABC News Medical Unit, who along with several other staff members resigned themselves to taste testing the little critters.
enjoy.
Not enough grasshoppers around here to fill my stomach... I'm thinking squirrels are a more viable option.
Of course, I'd like to fish and hunt for my own food, but the damn license fees required to provide my own food are cost prohibitive. I'm thinking squirrels might be hard to catch without a gun or trap.
Eventually, the market will just come up with their own numbers and ignore the state's. That'll be around the day it won't believe in the USD supremacy anymore.
arithemetic weighting vs. geometric weighting?
It was my understanding that there would be no math and the overwhelming majority of the citizenry would concur.
If prices are rising faster than wages, it doesn't matter how you account for it. Life is cash-based, not accrual-based.
Don't piss on me Senator and tell me it is raining down my back.
You all know the truth. Hell, most of America knows they are lying. What are you going to do about it? Nothing. You are powerless against it. You vote one crook out, and another takes his place.
In the end, it will all come crashing down. They can't continue to commit accounting fraud and not have it catch up with them. And, at some point, they may find their heads detached from the bodies and placed on pikes outside the Capitol. That's not a threat, you black-helicopter-email-reading-blog-spying-big-brother-snooping-Janet-Napolitano-lesbo-types, that's me looking at the future and saying you had better be prepared for some really angry Citizens when they see that you have destroyed their Country.
oh, and my own YoY inflation calcs say 13%. FU BLS.
By using a geometric average, what they are saying is that consumers are interested in the logarithm of prices.
So you add up the logarithm of the price of everthing in your shopping basket, then convert back to taking the expoential. I wish I could do this in the supermarket!
The fraud perpetrated here uses the Arithmetic-Geormetric Mean Inequality that states that the arithmetic mean is always greater or equal to the geometric mean, equality only occuring when all the numbers being averaged are equal.
CPI-U vs. CPPI
http://www.nowandfutures.com/images/cppi_vs_cpi.png
http://www.nowandfutures.com/images/cppi_vs_cpi2.png
http://www.nowandfutures.com/images/cppi_vs_cpi_short.png
CPI-U vs. CPPI vs. SGS-CPI
http://www.nowandfutures.com/images/cppi_cpi_wo_lies_vs_sgs2.png
http://www.nowandfutures.com/images/cppi_cpi_wo_lies_vs_sgs.png
http://www.nowandfutures.com/cpi_issues.html
Paid $1.50 for a pack of gum this morning!!! Not to mention the 20% increase in my health insurance premium.
Even the BLS shows a 10-15% hike in health insurance this year.
http://www.nowandfutures.com/images/health_insurance_bls.png
Alternate measures are at least 3% higher.
The Fed never counts "anti-hedonics." Anti-Hedonics is when you replace that forty year old Maytag washing machine with a brand new Chinese washing machine and it catches fire and explodes three months later. Or when you replace that 50 year old American Standard faucet with a brand new one made in China and six months later it has corroded into a pile of white dust.
The unintended consequences are that aging boomers won't retire, will have to work until they drop dead in their CVS cashiering jobs and therefore will not make way for kids who thankfully are just as happy to sit home and play Xbox all day and won't "participate" in the workforce. Welcome to Italy and most of Europe, it is coming slowly but it is coming.