CPI - do you believe the numbers?

[BearBones]

No. At least 3 reasons:
1. Strong disincentive to report inflation accurately. Do we trust government to make TIPs and SS payments accurately keep up with inflation?
2. Hedonics. While useful for some comparisons, hedonics measurements are nebulous and do not provide for the fact that many consumer items become less durable and dependable as they are upgraded and modernized.
3. Substitution. In my mind, this is the most egregious. Agree with the author of the following article that substitution of less expensive items for more expensive is largely PROOF of inflation, not the contrary.

http://seekingalpha.com/article/24933-s ... bsurdities

[BearBones]

If the substitution results in the same standard of living (pork chops instead of chicken breasts), then the CPI still makes sense as an inflation measure.  But if substitution results in a lower standard of living (chicken necks instead of chicken breasts), then it's not a very good inflation measure.

But why not follow the same basket of goods, as was done until 1999 (unless it is taste that changes rather than price)? Standard of living can be nebulous and easily manipulated. For instance, do I have the same standard of living if I shift from steak to ground beef? Chicken breast to chicken thighs? Fresh fruit to canned?

[melveyr]

But why not follow the same basket of goods, as was done until 1999 (unless it is taste that changes rather than price)? Standard of living can be nebulous and easily manipulated. For instance, do I have the same standard of living if I shift from steak to ground beef? Chicken breast to chicken thighs? Fresh fruit to canned?

Here is a somewhat dramatic example that proves why substitution must be taken into account to some degree...

Let's say that corn goes extinct due to some terrible virus and it's price skyrockets. So, a corn muffin ends up costing $100,000 dollars. Would you want a CPI that held the quantity of corn muffins consumed to be constant? Do you think that CPI would accurately reflect increases in the cost of living?

As a consumer, I would probably substitute away from corn and it's price movements would have less of an affect on my budget than if I had decided to keep my consumption of corn constant. I wouldn't find a CPI that held corn (or any other product) constant to accurately reflect my costs of living.

People give the BLS a hard time, but coming up with a price index is an extremely difficult and messy process riddled with assumptions. I wouldn't even know where to begin trying to do a better job.

[above the herd]

My vote is to replace the CPI with the Big Mac Index.

http://www.economist.com/blogs/dailycha ... _mac_index

[moda0306]

But why not follow the same basket of goods, as was done until 1999 (unless it is taste that changes rather than price)? Standard of living can be nebulous and easily manipulated. For instance, do I have the same standard of living if I shift from steak to ground beef? Chicken breast to chicken thighs? Fresh fruit to canned?

Here is a somewhat dramatic example that proves why substitution must be taken into account to some degree...

Let's say that corn goes extinct due to some terrible virus and it's price skyrockets. So, a corn muffin ends up costing $100,000 dollars. Would you want a CPI that held the quantity of corn muffins consumed to be constant? Do you think that CPI would accurately reflect increases in the cost of living?

As a consumer, I would probably substitute away from corn and it's price movements would have less of an affect on my budget than if I had decided to keep my consumption of corn constant. I wouldn't find a CPI that held corn (or any other product) constant to accurately reflect my costs of living.

People give the BLS a hard time, but coming up with a price index is an extremely difficult and messy process riddled with assumptions. I wouldn't even know where to begin trying to do a better job.

That^

[notsheigetz]

I like the Big Mac Index idea but the BMI acronym is already taken for Body Mass Index. Personally, I like PPI - The Purchasing Power index - an index reflecting the falling purchasing power of the dollar as opposed to rising prices. This will never happen as long as liars are running the government of course - in other words it will never happen. The mysterious phenomenon of rising prices can always be blamed on the rich and greedy but the falling dollar - well, everyone would eventually figure out who was to blame for that.

My vote is to replace the CPI with the Big Mac Index.

http://www.economist.com/blogs/dailycha ... _mac_index

[BearBones]

People give the BLS a hard time, but coming up with a price index is an extremely difficult and messy process riddled with assumptions. I wouldn't even know where to begin trying to do a better job.

Good example to prove the point, melveyr. And I get the need for it in unusual cases.

This subject came up a year or two ago, and I was surprised how people defended the accuracy of the CPI. Then we turn around and say that we don't trust TIPs because they created by the same folks that generate inflation. Interesting. I tend to be a lot more pro-government than the vast majority on this forum, yet I vehemently distrust CPI data integrity. Too many disincentives for it to be accurate.

[AgAuMoney]

As a consumer, I would probably substitute away from corn and it's price movements would have less of an affect on my budget than if I had decided to keep my consumption of corn constant. I wouldn't find a CPI that held corn (or any other product) constant to accurately reflect my costs of living.

Which is EXACTLY why the CPI is not an accurate measure of inflation.

Cost of living?  maybe.

Consumer price index?  Yes, but guaranteed to be imperfect. Because every time you change the index you somewhat invalidate comparisons with previous versions of the index.  Yet the index MUST change because what consumers purchase does change.  Same problem is faced with the S&P500 or DJIA and their "return" as compared with the actual return of someone trying to replicate the index.

[AgAuMoney]

I was discussing inflation with a friend yesterday, and the topic of the official CPI numbers came up.

Which CPI numbers?

CPI-U -- urban consumers

CPI-W -- urban wage earners and clerical workers

CPI-E -- elderly  (which, btw, should be what SS indexes to, and it is typically much greater than the CPI-U)

C-CPI-U -- chained CPI-U (which is what the gov't wants to use to index SS, and it is typically much less than the CPI-U)

Core CPI-U -- CPI-U minus food and energy

...

[MachineGhost]

I was discussing inflation with a friend yesterday, and the topic of the official CPI numbers came up.  I think the numbers provided by the BLS are probably pretty close to reality, though they obviously won't be representative of each individual's personal inflation rate.  What do you think?  Do you believe the numbers are pretty close to reality?  If not, why not and do you have another measurement you think is more accurate?

I used to believe in the conspiracy theories but after reading some of the academic literature (not propaganda), I have come around to the conclusion that the CPI is very accurate at what it is designed to do, even with the "upgrades" over the years.  It may even overstate inflation.

In a truly rapid inflationary expectations scenario, or even hyperinflationary, the CPI will become useless.  Extreme inflation increases by the minute, hour or day and the CPI is only updated every month.  So the CPI is fine as long as conditions do not get very extreme.

[craigr]

I've generally held that the CPI numbers in various forms are about 1% or so understated, but that's based on a more intuitive feeling which I admit is not very scientific. So an official CPI of 3% is really more like 4%. Again, just my view on things in terms of what is easy to get away with politically. You can argue for a very long time with people over inflation being 3% or 4%. They are just too close and there are too many variables where there is no way to pin down an answer.

Yet a 1% underreporting buys a lot of savings in terms of COLA payments, etc. in an economy. So it's worth lying about that.

However it's lot harder to say inflation is 10% when it's really 25% (like in Argentina right now). That big of a difference is spotted by everyone and there is no real good way to sweep it under the rug.

Also, each person has their own personal rate of inflation that is going to be different than whatever CPI they are using.

To be more scientific, I'd keep an eye the Billion Price Project at MIT to see if it is tracking the CPI well:

http://bpp.mit.edu/usa/

Right now it is, but I suspect under high inflation it will not. Reason is when inflation is low (or there is some deflation), there is not much incentive to lie about it. But when inflation is bad, then the political pressure to "do something" almost always includes lying because lying about the problem is easier than fixing it.

But under high inflation I wouldn't be surprised to even see sources like the Billion Price Project affected politically. In that case, I suggest some of the following fallbacks:

1) What is the price of common food (Big Mac Index)?
2) How much does it cost to ship a 10lb. package across the country?

The last one is interesting and proposed by my CPA when we were talking about this subject. UPS and FedEx roll in total costs constantly into their prices. They can do it much faster than USPS. So if fuel prices are spiking, UPS and FedEx raise the prices quickly. These costs also roll in labor, fleet maintenance, etc.

So our theory is by taking a 10lb package and shipping it between two fixed zip codes across the country could give you a good indication of inflation when combined with the food costs of a Big Mac. The Big Mac is an expression of a lot of costs rolled into it and the shipping is more targeted towards transportation costs which also affects the economy greatly.

[BearBones]

Let's say that corn goes extinct due to some terrible virus and it's price skyrockets. So, a corn muffin ends up costing $100,000 dollars. Would you want a CPI that held the quantity of corn muffins consumed to be constant? Do you think that CPI would accurately reflect increases in the cost of living?

As a consumer, I would probably substitute away from corn and it's price movements would have less of an affect on my budget than if I had decided to keep my consumption of corn constant. I wouldn't find a CPI that held corn (or any other product) constant to accurately reflect my costs of living.

One problem with substitution is that people (and stores) naturally shift from higher quality to lower quality goods as prices go up. I would not have as much problem with substitution if there was a reverse hedonics measure. I remember the taste of beef 30 years ago, and you cannot find anything like that in modern grocery stores. It it too expensive to produce for the average consumer. Same for corn. And tomatoes. Similarly, one reason why household appliances have not increased in price more than they have is because they are no longer manufactured to last more than, say, 10 years. Compare that to my parents' freezer that lasted almost 40.

[MachineGhost]

I don't think CPI-U actaully tracks urban consumer expenses very well.  Everything costs higher in the cities than in the big box stores out in the suburbs.

There's also the imputed rent factor for real estate ownership in the CPI.  I can't imagine that actually tracks urban consumers either.