Mike Walden's You
Decide: Is inflation measured correctly?
Dr. Mike Walden
North Carolina Cooperative
The man’s tone was
forceful, even with a tint of anger. “The government
is lying to us about inflation,” he boldly stated.
“They tell us inflation is a lot lower than it
really is. And they purposely don’t include products
like gas and food in their calculations to fool us
into thinking the economy is better.”
finishing a presentation to a civic group with time
devoted to questions and answers when the man made
his statement. Perhaps he was looking for an
argument, but I turned his points into a learning
lesson about the process and pitfalls of trying to
calculate the nation’s inflation rate.
federal government has been collecting price data
only since the early 20th century. This
was the time of the Industrial Revolution, with
people moving off farms and to cities. Rather
than raising and making everything they needed,
families began buying more products in stores – so
the prices of everyday consumer items became more
Like the majority of government
economic statistics, information about the prices we
pay is based on a sample. Yet the government’s price
sample is large, covering more than 200 categories
of products and services at more than 20,000 stores.
Also, it is incorrect to say the government excludes
food and fuel prices. These are included in the
survey and in the most commonly reported inflation
rate. There is a version of the inflation rate which
omits food and fuel, but only because these prices
are very volatile and therefore may cloud the
long-run trends in inflation. Still, this version is
not the government’s main price gauge.
the government collects the individual prices, each
is assigned a “weight” based on its relative
importance to the average household’s budget. So,
for example, gas has a bigger weight than men’s
ties. A weighted average price is then calculated,
and the inflation rate for a year is the percentage
difference between this year’s average price and
last year’s average price.
It’s important to
understand this calculated inflation rate is based
on the spending pattern of the “average” consumer.
But, of course, no one is exactly “average.” So, to
the extent your purchases are unique and different
from the “average,” then official inflation rates
may be higher or lower than what you experience.
The government’s statisticians generating the
inflation rate face three big challenges: One
is that the collection of products and services
people purchase changes over time. New products are
introduced and others are discarded. Computers
replaced typewriters, and cellphones are rapidly
taking the place of landlines. Also, how and where
people buy things change. Today, many more purchases
are made on-line and at “big-box” stores than in the
past. Over time, the government makes changes to
keep up with the trends, but the adjustments can
A second challenge arises when
people change how much of a product they buy in
reaction to a price change. Let’s say gas prices
rise. In response, most motorists will purchase
fewer gallons. This means the “weight” – the
relative importance of gas prices to all other
prices – may change. The government has a version of
the inflation rate which attempts to account for
this somewhat subtle – yet still important – impact.
Perhaps the biggest challenge – and the one
with the most controversial solution – is how to
deal with quality changes in products. For example,
standard features on most new vehicles today include
air-conditioning, power windows, CD player, and air
bags -- all items I didn’t have on my first car, a
1956 Oldsmobile! So it would unfair to include the
cost of these features in the inflation rate for car
prices between 1956 and today, because they
represent improvements in the quality of vehicles.
The government agrees, and therefore it employs
a statistical technique to remove the costs of new
features so that the remaining price of the product
allows an “apples to apples” comparison to earlier
versions. It’s an imperfect technique, but without
it the inflation rate wouldn’t only mean paying more
for the same thing, but in part would mean paying
more for a better thing.
And by the way, for
the cost of owning a home -- which is actually very
complex, because a home is both something we use, as
well as an investment – the government estimates the
price per square foot if the home was rented.
The government releases several inflation rates each
month, differing slightly by the kinds of specific
methods used to address the above issues. For 2013,
the rates showed a range between 1 percent and 1.5
percent for the annual inflation rate.
there’s a private alternative to the government
numbers. A couple of years ago, some economists at
MIT decided to make use of the massive amounts of
price data now available on-line to calculate their
own inflation rate. They call this effort the
“Billion Prices Project,” and it’s become a popular
“check” to the prices and inflation rates published
by the federal government. For 2013, the Billion
Prices Project inflation rate came in at 2 percent.
So is there a logical and defensible way to
estimate the inflation rate? Along with my skeptical
friend at the civic meeting, you’ll have to decide.
Dr. Mike Walden is a William Neal Reynolds Professor
and North Carolina Cooperative Extension
economist in the Department of Agricultural and
Resource Economics of N.C. State University’s
College of Agriculture and Life Sciences. He
teaches and writes on personal finance, economic
outlook and public policy. The College of
Agriculture and Life Sciences communications unit
provides his You Decide column every two weeks.
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