It’s Time to Ditch the Consumer Price Index (CPI)

So why does the government maintain such a transparently inaccurate and misleading metric? For three reasons.

That the official rate of inflation doesn’t reflect reality is obvious to anyone paying college tuition and healthcare out of pocket. The debate over the accuracy of the official consumer price index (CPI) and personal consumption expenditures (PCE–the so-called core rate of inflation) has raged for years, with no resolution in sight.

The CPI calculates inflation based on the prices of a basket of goods and services that are adjusted by hedonics, i.e. improvements that are not reflected in the price of the goods. Housing costs are largely calculated on equivalent rent, i.e. what homeowners reckon they would pay if they were renting their house.

The CPI attempts to measure the relative weight of each component:

Many argue that these weightings skew the CPI lower, as do hedonic adjustments. The motivation for this skew is transparent: since the government increases Social Security benefits and Federal employees’ pay annually to keep up with inflation (the cost of living allowance or COLA), a low rate of inflation keeps these increases modest.

Over time, an artificially low CPI/COLA lowers government expenditures (and deficits, provided tax revenues rise at rates above official inflation).

Those claiming the weighting is accurate face a blizzard of legitimate questions. For example, if healthcare is 18% of the U.S. GDP, i.e. 18 cents of every dollar goes to healthcare, then how can a mere 7% wedge of the CPI devoted to healthcare be remotely accurate?

In my analysis, the debate over inflation is intrinsically flawed. What really matters is not the overall rate of inflation, which can be endlessly debated, but the purchasing power of earned income, i.e. wages and the exposure to real-world costs.

In other words, those households with zero exposure to college tuition and the full costs of daycare, medical care and healthcare insurance may well experience low inflation, while the household paying the full costs of daycare, college tuition and healthcare insurance will experience soaring inflation.

Here’s one example of how CPI fails to capture real-world inflation/loss of purchasing power. Let’s say an employee works for a company or agency that pays his/her healthcare insurance. The monthly cost has risen from $1,000/month to $1,500/month. The employee’s wage has remained stagnant but the total compensation costs paid by the employer have gone up by $500/month.

Now the employer shifts that $500/month to the employee as their share of the healthcare insurance cost. Since the average full-time worker earns around $40,000 a year, and pays around 18% in taxes, their take-home pay is around $33,000 annually.

The employee’s co-pay of $6,000 a year ($500/month) represents 18% of their take-home wage. This is an 18% reduction in earnings, or the equivalent of 18% inflation (i.e. a reduction in purchasing power).

This shifting of the skyrocketing burden of healthcare costs acts the same as 20% inflation, yet it doesn’t even register in the current CPI.

The geography of inflation doesn’t register, either. Soaring rents in Brooklyn, NY and the San Francisco Bay Area have a profound effect on those exposed to these rapidly rising costs, yet these impacts are massaged to zero by national CPI calculations.

So once again we have a bifurcated society: those protected by the state from rising costs and those exposed to real-world reductions in purchasing power.Households that receive government subsidies and direct payments have little exposure to real-world healthcare costs, since they are covered by Medicaid, and modest exposure to housing if they receive Section 8 benefits (Section 8 recipients pay 30% of their income for rent, regardless of the market price of the rental). Retirees on Medicare also have limited exposure to the real-world costs of their care paid by the government.

If we analyze inflation by these two metrics, we find the middle class is increasingly exposed to skyrocketing real-world prices. Pundits in the top 5% have the luxury of pontificating on the accuracy of the CPI while those protected by government subsidies and coverage have the luxury of wondering what all the fuss is about. Only those 100% exposed to the real costs experience the full fury of actual inflation.

So why does the government maintain such a transparently inaccurate and misleading metric? For three reasons: 1) it is useful propaganda; 2) it suppresses the state’s cost-of-living increases and 3) it lowers the government’s cost of borrowing. The benefits of reducing COLA adjustments are self-evident, as is the benefit of borrowing money at low rates of interest, but the propaganda benefits are more subtle.

The key to enabling the endless printing of money that enriches the banks and the top .1% is low inflation. Asset bubbles can be inflated, ballooning the wealth of the owners of the assets, as long as inflation is near-zero.

Indeed, the Federal Reserve claims it must print money to counter low inflation.

Meanwhile, in the real economy, those exposed to the real costs of college tuition, healthcare, childcare, etc. are seeing their purchasing power evaporate like a puddle of water in Death Valley. The Fed needs low inflation to justify its continuing enrichment of the financial elite, and the Federal government needs low inflation to keep its COLAs and borrowing costs low.

There are two ways to mask real-world reductions of purchasing power: 1) skew the CPI by distorting the component percentages, hedonics and how costs are measured, and 2) protect enough of the populace from real-world increases so they no longer care. Seniors, who famously vote in droves, have no idea what their Medicare benefits actually cost. As a result, they have no experience of healthcare inflation /reduction of purchasing power.

This works in all sorts of industries. As I have often mentioned here, the F-35 Lightning fighter aircraft costs in excess of $200 million each, roughly four times the cost of the F-18F it replaces. This extraordinary inflation is not experienced directly by the taxpayer who is paying for the boondoggle, as the Federal government borrows trillions of dollars to pay for such boondoggles, effectively passing the inflated costs on to future generations.

These costs are hidden by the low cost of borrowing trillions to pay for boondoggles. If real-world inflation is (say) 5%, then interest rates would typically adjust to a few points above that rate, to compensate capital for the erosion of purchasing power. If the Treasury had to pay 7% to borrow money, the interest cost would soon cripple Federal spending. People would be forced to focus on how all those trillions of dollars are being spent, and to whose benefit.

But with borrowing costs so low, nobody cares.

The solution? One, abolish the Fed and let the market discover interest rates, and two, abandon the simplistic notion that one number of inflation has any meaning in a complex economy with numerous subsets of exposure to market costs and the loss or gain of purchasing power.

Will we muster the will to look past failed models and metrics? Sadly, the answer is no. Why?

As I noted yesterday in What’s the Difference Between Fascism, Communism and Crony-Capitalism? Nothinga system set up to enrich political and financial elites is incapable of reform. the only way the CPI will ever be replaced is when the Status Quo collapses in a heap of lies and insolvency. Until then, propaganda and gaming the system to protect vested interests will rule.

Tagged with: , , , , , , ,
7 comments on “It’s Time to Ditch the Consumer Price Index (CPI)
  1. BK says:

    “…the only way the CPI will ever be replaced is when the Status Quo collapses in a heap of lies and insolvency. Until then, propaganda and gaming the system to protect vested interests will rule.”

    This is sadly correct.
    Things are way past the point of fixing.
    There is nothing to stop and nothing to fix, because it’s like trying to stop a raging elephant by throwing marshmallows at it.
    The whole rotten system has to collapse at some point.

  2. richard says:

    “Will we muster the will to look past failed models and metrics?”

    Begin by a) noting that inflation is an individual experience, and that b) most, and especially the middle incomes experience both inflation and deflation. That in turn means that if “we” want to use 1980’s metrics to measure inflation, personal expenditure allocations have to match, including, perhaps, much higher proportions of income spent on food.

    Then use price inflation as intended, as an estimator of the true wealth produced by the economy.

  3. Dylan Bowker says:

    Many moons ago when analyzing the CPI, I discovered a flaw so obvious I found that it could only be attributed to conspiracy or utter incompetence.

    It’s mathematically impossible for CPI to meaningfully reflect consumer prices, because as this articles shows: the method used to weigh basket components is incorrect.

    I contacted Statistics Canada about this Gong Show, and they indirectly responded “This is how other countries do it,” and have not addressed this problem.

    I’m glad this issue is still being raised.

    We can send men to the moon, but we cannot accurately calculate the cost of living? Bullshit.

    Fortunately it’s possible to construct an accurate CPI based on the data StatsCan data. It sounds like a rainy afternoon project.

  4. Useless Eater says:

    I think it is rather convenient that, when SSI can use these CPI (and other inflation metrics/statistics) to cite a particular, and yet minimal, raise in benefits to (supposedly) cover the cost of inflation, other entities can cite certain other particular metrics/statistics to (supposedly) justify their increases in the prices of their services, like USPS postage, for example. And yet, I find myself wondering that, if the costs of everyday services are increasing at a different rate than other, “benefit”-related changes, how can a CPI ever be figured with any amount of accuracy at all, especially when the higher cost of services are to (supposedly) figured into the cost of living/inflation benefit increases. I cannot even accidentally spell certain words wrong in comment sections like this with my cheap, run-of-the-mill computer without an automatic correction fixing some of my errors for me, and I am supposed to believe that, if there are errors present in the CPI figures, then it might be due to a faulty process, or human error? Convenience, it seems, has no boundaries when it comes to containing “accidental” and “faulty” and “human error” corruption.

  5. Bruce says:

    I iz liking cheaper laptops and phones and TVs and last-gen games. I iz hatin’ house prices yo. I’ll never get outta da hood.

  6. Bruce says:

    We can send men to the moon, but we cannot accurately calculate the cost of living? Bullshit.
    Some would say the first bit is BS too, yo.

  7. Big Wave says:

    Manipulating the CPI is just more theft by the unconstitutional Fed… look at all the trillions the Fed has stole from old folks trying to save and not gamble with their hard earned money…we live in a country ruled by Thieves…the answer is tipspartydotcom

Watch the latest Keiser Reports:

Buy Gold Online
Buy Gold Online