Gyroscopic Investing

MIT has been tracking their own version of inflation, and it appears to be pretty close (over CPI-U by about .6% since 2008).



I figured this might be useful for some people wondering how reliable CPI is... at least for now.

In 2007 I was going to do something very similar and even started to write some code for it but decided I just didn't want to mess with the project. My feeling has been for some time that the CPI understates inflation by 1-2% a year and the Billion prices project tends to reflect this idea so far.

I figure a fudge factor that is 1-2% under actual inflation is enough for the government to save a significant amount of money on COLA payments, but not so far out of whack that they have some plausible deniability about the figures. A higher figure would become too obvious.

It will be interesting to see how this graph moves if high inflation starts coming into the US. I suspect the 1-2% gap will grow. Or maybe the people at MIT will simply be encouraged behind the scenes with threats of Federal funding reduction to "fix" the algorithms they are using.

craigr,

It may seem like nit-picking, but since 1% means a lot in a world of compounding inflation, I have to take issue with your assertion of "1%-2% fudging."

Over a 3+ year period, BPI only captured about .6%-.7% cumulative difference.  I would say that the BPI gives CPI a little more legitimacy than you seem to be suggesting.

moda0306 wrote: craigr,

It may seem like nit-picking, but since 1% means a lot in a world of compounding inflation, I have to take issue with your assertion of "1%-2% fudging."

Over a 3+ year period, BPI only captured about .6%-.7% cumulative difference.  I would say that the BPI gives CPI a little more legitimacy than you seem to be suggesting.

The last three years has been the first time since the 1930s we have had deflation. We will have to see how it plays out going forward. But I stand by my statement. Also rate of inflation varies by person. The CPI is a gross measuring tool. It is not an exact science.

Interesting. Actually looks like the 2 graphs may be diverging, but too short a period of time to tell much. Here is CPI calculated as it was in 1980. The greatest divergence occurred when the Clinton administration introduced "hedonics," substitution, and "geometric weighting" to the CPI calculation, all tending to reduce CPI compared to prior calculations. Of the 3, hedonics was the most egregious, IMO.

Note that, if you mentally superimpose the graphs mid 2008 to date, there isn't much visible difference, just as there is not in the BPP vs CPI graph you have shown.



References:
http://www.shadowstats.com/article/consumer_price_index
http://www.chrismartenson.com/crashcour ... zy-numbers

The shadowstats article says CPI is understated by 7%.

I can't help but think this is a gross exaggeration.

Does BPI include housing?

It obviously doesn't include interest rates (i.e., the "price" of money).

I have to think the BPI uses a rental equivalent for housing, just as CPI does.

This is flawed, of course, but so is any other method... as housing can drop in price, and a huge portion of people can still have the same monthly payment that they did when their house was worth $80k more.

I think rental equivalence is about the best you can do, as long as you include a big-fat bolded asterisk.

moda0306 wrote: The shadowstats article says CPI is understated by 7%.

I can't help but think this is a gross exaggeration.

Could be. But why not exaggerate the last few years too while the author was at it? When I first saw it, I was surprised how flat both lines were. My experience has been one of even more exaggerated inflation, especially food and energy.

IDK... the author's attitude regarding inflation measures is a bit juvenile.

I can understand having issues with calculating "core" inflation.  I can also understand having issues with "improvements to products" (aka, cleaner gas that's more expensive doesn't necessarily increase CPI).

But to sarcastically brush these off as completely completely irrelevant or conspiratorial is inappropriate.  It actually does help in the short term to look at Core Inflation if you're trying to decipher trends... aka, whether inflation is getting baked into the economy.  Also, if gas is much cleaner today, then there is some legitimacy to trying to capture that increased benefit by not simply raising CPI.

The author brushes both off in a sarcastic tone, stating that the supporters of such adjustments have a hidden agenda.

Some may, but I think more adult debates can happen on the matter.  I love competing ideas and statistics, especially to government-produced ones, but let's not act like everything the government does to adjust CPI is to serve some hidden agenda.

moda0306 wrote: I have to think the BPI uses a rental equivalent for housing, just as CPI does.

This is flawed, of course, but so is any other method... as housing can drop in price, and a huge portion of people can still have the same monthly payment that they did when their house was worth $80k more.

I think rental equivalence is about the best you can do, as long as you include a big-fat bolded asterisk.

The reality for a typical family could be that they ARE paying more for milk and eggs and gas, but in this market they can buy the largest item they are ever likely to buy (a house) for 20%-40% less than it cost several years ago, and "buy" money to finance the purchase at the cheapest prices (i.e., lowest interest rates) in decades.

For that family, I would say that inflation in recent years has done nothing to their purchasing power OVERALL, and in fact the same amount of money for them will go WAY farther than it would have gone a few years ago.

MT,

Totally agree... which is why CPI should be looked at as simply one reasonable person's way of measuring the near-immeasurable, from which we can give our "ifs, ands or buts."

I'm glad they (gov't and MIT) go through the work to give us these measurements, but they are not good examples of the constraints of the average American, like there even is such a thing... you hit that nail on the head.

I don't put much validity in the shadow stats stuff. That big of a difference would be obvious to everyone.

The CPI is again a gross measure. And yes it can be changed for whatever legitimate, or not legitimate, reason. Also again each person is going to have their own personal rate of inflation depending on their own life circumstances.

To follow up on Craig's thought, to me prices are not really comparable over more than perhaps a decade. For example, how do you compare prices before and after the invention of telephones, or automobiles, or frozen food, or personal computers? There are periods of incremental change that are somewhat comparable, and there are drastic changes that make old prices irrelevant. A basket of goods that holds an airplane trip, a frozen burrito, and a dose of antibiotics in it is not comparable in a linear way with a basket containing a 3 week steerage class voyage, salted fish, and the clap.

craigr wrote: I don't put much validity in the shadow stats stuff. That big of a difference would be obvious to everyone.

Its just a graph of the same basket of goods measured in the way it was in 1980, isn't it. And that big a difference may be obvious to quite a few, actually. Unless the CPI heavily weights items that are typically purchased with debt (houses, autos), it is hard for me to believe that we have had tame 2.4% inflation over the past 15 years.

Come on you guys! Where are the angry, suspicious, conspiratorial, libertarian types when you need them? Bet they are all camped out on Wall Street with no internet connection. Ha.

cowboyhat wrote: To follow up on Craig's thought, to me prices are not really comparable over more than perhaps a decade. For example, how do you compare prices before and after the invention of telephones, or automobiles, or frozen food, or personal computers? There are periods of incremental change that are somewhat comparable, and there are drastic changes that make old prices irrelevant. A basket of goods that holds an airplane trip, a frozen burrito, and a dose of antibiotics in it is not comparable in a linear way with a basket containing a 3 week steerage class voyage, salted fish, and the clap.

Yes, I would not want to work at BLS. But I bet most of the things in the basket of goods being measured in the CPI are roughly comparable, like milk, gasoline, an auto, suit, and a 2x4. And in trying to make things more comparable, the brilliant folks in prior administrations came up with "hedonics." So the price of such things as a modern telephone is slashed in price for the CPI measurement because it is deemed more valuable now. Doesn't matter if the cost has gone up for a base model or if the typical phone lasts years as opposed to decades. It has more value because it has more buttons. To an extent this is true. But shouldn't such things as quality and lifespan also be measured if one is to estimate value by anything other than price of a base model of a product?

BearBones wrote:

craigr wrote: I don't put much validity in the shadow stats stuff. That big of a difference would be obvious to everyone.

Its just a graph of the same basket of goods measured in the way it was in 1980, isn't it. And that big a difference may be obvious to quite a few, actually. Unless the CPI heavily weights items that are typically purchased with debt (houses, autos), it is hard for me to believe that we have had tame 2.4% inflation over the past 15 years.

Come on you guys! Where are the angry, suspicious, conspiratorial, libertarian types when you need them? Bet they are all camped out on Wall Street with no internet connection. Ha.

One place where there has CLEARLY been high inflation in recent years is in the price of concert tickets.

MediumTex wrote:

BearBones wrote:

craigr wrote: I don't put much validity in the shadow stats stuff. That big of a difference would be obvious to everyone.

Its just a graph of the same basket of goods measured in the way it was in 1980, isn't it. And that big a difference may be obvious to quite a few, actually. Unless the CPI heavily weights items that are typically purchased with debt (houses, autos), it is hard for me to believe that we have had tame 2.4% inflation over the past 15 years.

Come on you guys! Where are the angry, suspicious, conspiratorial, libertarian types when you need them? Bet they are all camped out on Wall Street with no internet connection. Ha.

One place where there has CLEARLY been high inflation in recent years is in the price of concert tickets.

Health insurance has gone way up. Easily 25-40% increases have been happening at my provider for instance.  That is for all insured, not just people with claims.

craigr wrote:

MediumTex wrote:

BearBones wrote: Its just a graph of the same basket of goods measured in the way it was in 1980, isn't it. And that big a difference may be obvious to quite a few, actually. Unless the CPI heavily weights items that are typically purchased with debt (houses, autos), it is hard for me to believe that we have had tame 2.4% inflation over the past 15 years.

Come on you guys! Where are the angry, suspicious, conspiratorial, libertarian types when you need them? Bet they are all camped out on Wall Street with no internet connection. Ha.

One place where there has CLEARLY been high inflation in recent years is in the price of concert tickets.

Health insurance has gone way up. Easily 25-40% increases have been happening at my provider for instance.  That is for all insured, not just people with claims.

No doubt.  Higher education costs have also gone up.

The cost of government is also a lot higher.

In the UK many costs have gone from zero to actually paying for stuff . I feel sheepish when people talk about high university fees because my generation in the UK got free tuition and also living expenses paid. Dentistry used to be government funded in the UK. Now in the UK, state dentistry is dysfunctional  and so if you want teeth fixing you need to pay. I'm not saying that those things shouldn't be paid for by those receiving them, I'm just saying that it is a very big thing to bear in mind when comparing living expenses now and 20 years ago especially when many people are paying more tax now than they would have been then.

To my mind all of this misses the really big issue. If you want to be rich enough that the government comes running when you snap your fingers- that is where we have really seen inflation. In 1960 if 10000 car mechanics had made a political donation of a days wages- that would have done much to counteract a donation from someone on the forbes 100 list. That is what has really been eroded. The way to get a handle on that is simply to compare your wage/net worth against the government debt (AKA total private savings).

I'm not defending price increases in higher educational costs with this comment. It is worth noting that a college education 70 years ago was unnecessary for 95% of people in the US in terms of their economic prospects, likely had little + impact on the potential earnings of people who got college educations, and was therefore a hideously expensive luxury in terms of opportunity costs. Today for most people a college education is a essentially an insurance policy against unemployment. Not getting a college education is perceived as a gamble. Is a state college education expensive in terms of a partial lifetime insurance policy against unemployment?

With regard to health care costs, the question I ask myself is what else should we spend our money on as a society? I can see being interested in getting more value from a health care dollar, or spending health care money more rationally (instead of in the last week of life), but being educated and healthy are things that make me really happy. Spending lots of my income on being healthy seems like a reasonable choice to me.

When I think about ways I could be miserable they pretty much fall into: ill, ignorant, and oppressed.

cowboyhat, I totally agree that many health care advances such as hip replacements etc make a huge difference to those that get them and seem well worth the cost. I guess the issue here is how they should be included in inflation stats. Is the fair way to measure inflation by including "comprehensive" health care cover or by saying that amputating a leg costs less now than fifty years ago?

To me the issue is that as a population we have created new technologies etc and yet Joe Average is supposedly expected to demand a slice that doesn't expand along with the overall pie.

cowboyhat wrote: With regard to health care costs, the question I ask myself is what else should we spend our money on as a society? I can see being interested in getting more value from a health care dollar, or spending health care money more rationally (instead of in the last week of life), but being educated and healthy are things that make me really happy. Spending lots of my income on being healthy seems like a reasonable choice to me.

When I think about ways I could be miserable they pretty much fall into: ill, ignorant, and oppressed.

There is very good evidence that the increasing health care dollars spent in the US do not necessarily translate to better health. Like so many thing, it depends on how it is spent. And much of the escalation of health care expenditures is due to overutilization of pharmaceuticals (especially the latest meds vs inexpensive generics), unnecessary testing (e.g., CTs for many headaches that present to the ER in order to avoid malpractice risk), procedures (e.g., prostate biopsies due to elevated PSA, colonoscopy in the elderly), and nursing home costs.

What could we better spend our money on? Although I receive my income from health care, I would prefer that this country directs it resources more toward the next generation, such as a rational energy policy (especially sustainable energy production and reducing energy consumption), reduced debt, and reduced taxation afforded by a rational revision of our entitlement programs (Medicare, Medicaid, and SS).

Cowboyhat, I realize that things are a bit different in the UK as compared to the US with regard to both higher education costs and healthcare. You've undoubtedly got some fat that could be trimmed, but perhaps not as much as the US.

BearBones, in the UK we probably do have waste that could be trimmed in health care but at the same time we have "trimmed" some other bits to crazy extents. The worst problem IMO is that we use delay as a cost postponing method. So hip replacements get done "eventually" etc. A classic example is doing adjuvant radio therapy after cancer surgury or chemotherapy. Clearly it shouldn't in principle cost any more to do it on schedule but instead it gets done after weeks of delays due to waiting lists etc. Obviously cancer relapses etc that result just add more costs. Also in some districts, general practice doctors have some of their pay conditional on not referring too many patients through to specialists. The result is that serious diseases get to late stages before diagnosis. Our general practice doctors have no equipment to hand and are supposed to make life and death descisions based on a five minute conversation.

About the high costs of drugs, to my mind what is needed is to scrap the current system of patent protected sales and instead pay pharma companies a one off payment for each new drug developed based on an assesment of the improvement in efficacy. Drug sales are not anywhere near being free market phenomenon now. We should forget the pretence and just have a no-nonsense payment for drug discovery system IMO. Then it would cost no more to give everyone who needed the drug the drug and also there would be no marketing costs (currently more than the research costs) and no pressure to inappropriately give the drugs to patients who would be better off without them.