What is the True Inflation Rate?

Posted By PK Last updated March 21st, 2012 20 Comments

One of our favorite things to debate here on DQYDJ is the validity of the inflation rate. On the whole, we think that the method the government uses to track inflation is a decent gauge of the prices an ‘average person’ in America pays for a particular basket of goods.

That strict definition is where many of you have a problem. Who among us is a ‘typical person’, who spends their money in the exact proportions as the average of all Americans? Well, no one.

So, let the complaints continue, and let’s look at a few other inflation measures that compete with the Consumer Price Index.

The PCEPI – Personal Consumption Expenditures Price Index

The PCEPI is an inflation measure (technically a deflator) based on just the Personal Consumption component of the Gross Domestic Product of the United States. We first discussed the PCIPE in our article on whether college students are better off today or in the past.

Even though a common complaint about the CPI is that it understates year to year price changes, it actually tends to understate changes in price over longer ranges of time. Since inflation should factor in when product are substituted and the PCE contains substitution by default, it is likely a better indicator to use over longer time periods. So while some looks at the past use the CPI as a deflator, it’s often more fair to use the PCEPI to determine the cost of goods in the past.

You can find the PCE Price Index (like I do) on the St. Louis Fed website.

The Billion Prices Project

The BPP is a very interesting project from my standpoint, since it leverages e-commerce to come up with a real time daily glimpse of a basket of goods online. It tracks prices online across many countries, and can watch how the relative prices of products shift when exchange rates vary. When new places sell a product (and a new page is found), the index automatically factors in the new seller to the index.

Check out the Billion Prices Project at MIT.

The Everyday Price Index

Think the CPI is weighted too heavily to big ticket items like cars, trips, building materials and technology? You aren’t alone, and you’re right in thinking that low-tech products have increased rapidly in price the last few years. The American Institute for Economic Research agrees and took the idea to its logical conclusion – only counting items which the average American buys once a month or more. Toothpaste in; computers out. From the site:

“The index includes food and beverages, household energy products and services, other utilities, motor fuel, prescription drugs, child care fees, phone services, personal care products, and other goods and services purchased on a regular basis. “

Check out the AIER and the EPI.

A graph of the EPI since 1987 (AIER)

Other Indices

There’s no shortage of indices compiled to track inflation (Big Mac Index, anyone?), especially ones which have come into existence in the last ten years. We just wanted to shine a spotlight on a few of the more interesting ones for your next scheduled argument!

Which index do you like the best? Do you think the CPI under or overstates true inflation? Do you like the Big Mac Index?

If you enjoyed this post, let others know!

Bichon Frise

I like my own personal estimate of inflation. By tracking my expenses I understand what the things I buy and need change in price. I was just talking with a co-worker about electricity bills in a hell hole we both lived in at some point of lives, but about 17 years apart. The electricity cost was about the same at the peak month for similar size homes.

The CPI is a tool which helps to track trends in our complicated economy. While not perfect, I have a hard time thinking of a better system. EPI misses the mark, while we may not need a new car, TV, roof etc “everyday,” these do represent things the avg consumer buys and amortizes over the life of the product and they tend to be “big ticket” items. Including only “everyday” purchases may help to explain why we feel inflation is higher, but it doesn’t describe true inflation.
- http://www.dqydj.net/ PK
  
  What do you think of the billion prices project? Impressive display of technology or useful indicator?
  
  I do like that it has been pretty good about ‘predicting’ the CPI, without all the expense of logging the CPI itself introduces.
- Brad
  
  Disagree that big ticket items offset everyday expenses, since big ticket items are amortized over such a long time (esp. when my grocery and electric bill make me have to get 10 years out of my car). My grocery expenditures are (now) seven times my outlay for automobiles. Also, the USG does have issues that would drive keeping the CPI conservative, and that they have had to “manage” the calculation the last 20 years to do so. I think EPI feels more correct … because it is.
  - http://www.dqydj.net/ PK
    
    Finding an inflation measure which hews closely to your life is the key. If you take a close look at the EPI, there was a time when the goods tracked actually grew at a slower pace than the CPI. It’s possible we get into that sort of point again in the cycle.
freeby50

It always irks me when people say the governmet CPI figures are ‘wrong’ because they disagree with the methodology or they cite individual anecdotal points like how milk at their grocery store is up 50 cents in the past couple weeks.

As we can see there are many ways to measure inflation. I don’t think
any one of the methodologies is ‘right’ or ‘wrong’ but they’re just all a
little different. And they’are all just broad averages and of course peoples individual circumstances will vary.
- http://moneymamba.com/ JT
  
  The anecdotal points are annoying, but even still – there are some very big differences that make CPI pretty much worthless. Everything that is “necessary” or which has a pretty inelastic demand curve is going up in price far faster than everything else. Health care, prescription drugs, housing, and college costs are just some of many.
  
  Retirees – and anyone with a high proportion of fixed-income sources, and limited expenses – are taking a licking. I mean, even if you beat 2% inflation by earning 4% a year, you’re still lagging behind food, energy, and health care costs. Those costs make up a huge proportion of expenditures for the poor and retired.
  - http://www.pfblogwatchdog.com/ Bichon Frise
    
    Retirees and the poor need shelter just as much as the next guy. Or, as has been popular in America, a car. While energy and food may be rising, the bigger ticket items are going lower, which help to offset the “everyday” items. Again, we shop regularly for food, not so much for a washer and dryer. This is why inflation feels higher than it really is. But reality is, take out our biases, and it isn’t as bad as it feels.
    - http://www.dqydj.net/ PK
      
      I think that some demographics probably will see sustained inflation, even when teasing out biases… in my head I’m thinking of a middle class suburban couple with multiple college aged children (heh – that’s a rough one). Medicine is usually more shielded from view, but I can see some groups getting hit hard by the specter of medical inflation.
- http://www.dqydj.net/ PK
  
  For that perspective, CPI is pretty close to perfect – it measures a basket of goods bought by an average American (in average proportions), and does so in a repeatable manner.
  
  That said, I like the ‘inflation competition’ we are seeing. For some people, these other measures might have a much better bead on their spending – so without tracking a budget, people can see “well, hey, necessities are rising at xxx%” or whatever. Of course, I agree the CPI gets way more flack than it deserves…
http://www.thegeezergadgetguy.com/ Thad Puckett

The measure of inflation that is most accurate for me is how much my monthly budget is impacted by the cost of fuel. When that goes up, as it has been for the past 6 months especially, the impact on my family is significant. When the ripples of higher energy costs go throughout our economy, it hurts even more.
http://marriedwithdebt.com/ John @MarriedWithDebt

I use the McDonald’s Dollar Menu. Yep, still a dollar = no inflation.

Seriously, though, the EPI looks more attractive for taking into account real life on the ground.
- http://www.dqydj.net/ PK
  
  But… are more things coming off the menu? Are the ingredients changing? Haha… insidious inflation might still be replacing your ingredients!
Economically Humble

now we are talking! This is a great post (and this is my first time here.. GREAT blog).
- http://www.dqydj.net/ PK
  
  Thanks so much; you’ve got a nice site yourself!
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101 Centavos

Whatever index we use, the trendline is clear…. UP!
- http://www.dqydj.net/ PK
  
  And the Fed is guaranteeing roughly 2% increases in the CPI for the foreseeable future…
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http://utsa.financialplannerprogram.com/ Financial Planning

Thats a good post. Everyone in such times would be attracted to know more about inflation.
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What is the True Inflation Rate?

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