Mises Daily Articles
The Three Stooges of Inflation
The U.S. Department of Labor's Bureau of Labor Statistics (BLS) recently announced that the Consumer Price Index (CPI) rose 0.5 percent in January, its biggest increase in nearly a year. The CPI core rate, which excludes energy and food prices — like any of us can go without gasoline or food — rose 0.2 percent. Both increases surprised analysts, but normal people — people who actually pay money for goods and services — weren't surprised.
Federal Reserve Governor Ben Bernanke told the press that the January numbers were "consistent" with continuing low inflation. Another currency crank, William Poole, president of the Federal Reserve Bank of St. Louis said "inflation will likely remain at its current low levels in the U.S. for the rest of the year."
Prices rise constantly, yet Fed representatives say that inflation is low. In fact, half of the time Bernanke worries aloud about deflation. As if prices have even the remotest chance of falling, while the Fed creates money by the bale. Yet, the CPI seems to support what the three stooges of inflation — Poole, Bernanke and Alan Greenspan — are saying; inflation, as measured by CPI, is relatively quiescent.
From January of 1984 to this January the CPI index rose from 101.9 to 185.2, an increase of 81.7 percent. Nothing to brag about, that's a near doubling in prices over those twenty years. But, does that really reflect what prices have done for the past twenty years? Not hardly. The money supply, as measured by M3 has more than tripled from $2.7 trillion in January 1984 to $8.9 trillion last month.
So, why hasn't CPI — what the BLS calls "the most widely used measure of inflation" — risen as fast as the mountain of money the Fed has created? The government doesn't want it to. As the BLS website explains; "The index affects the income of almost 80 million people as a result of statutory action: 47.8 million Social Security beneficiaries, about 4.1 million military and Federal Civil Service retirees and survivors, and about 22.4 million food stamp recipients." And that's not all; the cost of school lunches is affected by CPI, as well as contracts in the private sector involving rents, royalties, child support payments and alimony are tied to changes in the CPI. The government clearly has a vested interest in suppressing CPI, as stated on the BLS website; "Since 1985, the CPI has been used to adjust the Federal income tax structure to prevent inflation-induced increases in taxes."
BLS statisticians, since 1995, have been eliminating "biases" that they believe "cause the index to overstate inflation." According to the Federal Reserve Bank of San Francisco website the elimination of these biases lowered inflation by more than half a percentage point by 1999.
In a 1996 report prepared by a panel of experts chaired by Michael Boskin, four biases were identified that supposedly served to overstate inflation by 1.1 percentage points per year. Substitution bias doesn't "capture the savings that households enjoy when they change their spending in response to relative price changes of goods and services." Outlet bias doesn't reflect the savings consumers receive when shopping at discount stores. New Quality bias occurred, according to Boskin, because the CPI didn't take into account quality increases of new products and New Product bias occurs because new products don't appear in the index until they are commonplace items.
To deal with these biases and keep the CPI low, the BLS uses what they call hedonic regression to strip prices of the four biases, especially the quality bias. Thus, you and I may be paying more for a computer than we would have a month or year ago, but the BLS for the purposes of figuring the CPI say that the price of computers has fallen because of quality improvements.
Boskin went as far as telling the Wall Street Journal that a person who substitutes chicken for high-priced beef is lowering the cost of feeding the family. "This is pure sophistry," Lew Rockwell points out, "along the lines of claiming umbrellas not only keep you dry but also reduce the incidence of rain. Boskin has confused the response to the problem (using a cheaper substitute) with the problem itself (everything getting more expensive)."
Everyone knows that the housing market is on fire, with double-digit gains in the median price of homes in many parts of the country. However, the BLS doesn't see it that way. BLS statisticians claim the cost of housing rose only 2.2 percent from a year ago. The largest component of CPI, at 32.9 percent, is "shelter" but for-sale housing prices are not used in the index. Something called "Owners equivalent rent" (OER) which measures what a house or apartment might rent for is what is used in the CPI.
The February 27 edition of Grant's Interest Rate Observer points out the difference that using OER, as opposed to using house prices, makes in the CPI calculation. "In the past four quarters," writes Grant, "the house-price version of CPI registered year-over-year changes 100 basis points or so greater than the OER version."
A point here and point there and pretty soon you have real inflation.
Besides massaging housing price increases away, the majority of items in the CPI index are hedonically adjusted. Jim Rogers, in his book Adventure Capitalist, wrote, "56 percent of the figures that go into the Consumer Price Index are now hedonically adjusted." Rogers has received letters from former BLS employees "who say that, indeed, they were always instructed to 'smooth out' any large increases."
And the economists at the BLS are far from done. They now have their sights set on deflating the price increases in health-care, which makes up 4.6 percent of the CPI index. By anyone's accounting healthcare prices have exploded. But the pointy-headed wonks at the BLS know better than we do. By the time they get done adjusting medical prices for quality adjustments, the BLS will claim that a trip to the hospital has come down in price.
The Federal Reserve Bank of San Francisco website states; "Since the Fed uses the CPI as an indicator of price inflation, a more accurate index should make anti-inflationary monetary policy more effective. The public will have a better indicator to check how well the Fed is doing its job." How laughable, we know what the Fed is doing, creating money day and night. As Lew Rockwell wrote in The Free Market, "Lacking any strategy for getting rid of inflation, they intend to redefine it."
"Inflation is much greater than the government admits," wrote Representative Ron Paul last July. "The real measure of inflation is the increase in the money supply." According to the BLS the inflation rate for the past year was 1.9 percent. During the same period, M3 increased 4.3 percent. Those who are searching for the proper inflation index to use in contracts may want to scrap the CPI index and use Ron Paul's definition.