Fri 12/16/11 9:46 AM – Is Consumer Price Index Right?

Today the CPI was reported as being flat from last year. What? – you say, how can that be since I pay more for things than I did last year?

The answer is a little complex but simply put, because of the tremendous incentive for the government to understate the CPI – it is after all used to calculate Social Security payments and many other government costs the Bureau of Labor Statistics (BLS) began changing the formula during the Clinton and Bush II administrations. The BLS no longer measures the change in a fixed basket of goods but the “cost of living.” That sounds like a distinction w/o a difference. Far from it. Below is a chart showing the difference between the old system (SGS) and the new (CPI-U). Click the chart to enlarge.

Here is another chart showing recent years.Both charts are courtesy of Shadow Stats

There are a couple things going on.

1. The BLS gives less weight to rising prices than falling prices because it assumes people will substitute cheaper goods for more expensive goods when prices rise, as in substituting hamburger for steak. So if you thought a fall of 10% in prices for gasoline is offset by a 10% rise in prices for food, think again. The fall in prices gets more weight so in that simple example according to the CPI-U overall prices went down.

2. As goods improve their price is adjusted lower. I have talked about this before. A VW Beetle today has far more standard features and better crash protection than a 1970 VW Beetle so in CPI-U terms the price for the new VW is adjusted down. Another example is putting in place a federally-mandated additional additive to gasoline that reduces emissions. The 10 cent additional cost is not counted as inflation because there is the benefit of cleaner air.

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