The reported rate of inflation is a lie
May 16th, 2007I’ve been reading and learning about the Consumer Price Index (CPI), otherwise known in layman’s terms as the ‘rate of inflation.’ The CPI is calculated by the Bureau of Labor Statistics (BLS) and is reported periodically (monthly is the most common number quoted). The original idea of the CPI was to periodically collect the prices for a basket of consumer goods in order to gain information on price increases or decreases. So far so good.
What I’m learning, however, is that the CPI grossly understates actual consumer prices. To understand why, you have to known a little more about how CPI is calculated. Bear with me, this’ll get good.
Here are the components of the CPI:
Notice the three largest pieces of the pie: housing, transportation, and food. Here’s where it gets good. Let’s take a look at housing for evidence of how the CPI understates inflation.
How CPI underestimates the cost of housing
Within the housing category are three subcategories - shelter, fuel and utilities, furnishings. Within the shelter subcategory is our bogey - owners’ equivalent rent.
Every month, BLS polls 50,000 landlords and tenants to come up with owners’ equivalent rent. But because of the recent housing bubble, rents nationwide have been suppressed as more people could ‘afford’ a home and bought one. This caused a glut of unoccupied rental units and hence kept a lid on rents. That’s why people like Flexo at Consumerism Commentary are now comparing the wisdom of renting versus buying.
We know from government census data that the homeownership rate as of 2005, the most recent data available, stood at 68.9% That means 31% of the U.S. population rents. So when the CPI is calculated, 23.4% of the entire number is derived from 31% of the population’s situation. The increased cost of housing for 69% of the U.S. population is ignored. According to the OFHEO (the government agency charged with tracking these things), for 4Q2006 home prices were 5.9% higher than a year earlier. That’s after three years of price appreciation in the teens.
After looking at the situation in this light, I believe the CPI understates actual inflation to a surprising degree. Why would the feds publish this lower inflation number? Oh, I can think of a couple of reasons…
- Lower COLAs for military and other government workers
- Smaller COLAs for Social Security recipients
- Lower payments for Treasury Inflation Protected Securities (TIPS) and similar bonds
- Tax brackets are adjusted more slowly, increasing tax revenue
