Economists, investors, and pundits have complained about inflation measures ever since the national CPI was introduced in 1921.
Mark Twain captured America’s spirit of skepticism when he listed the three kinds of lies— “lies, damn lies, and statistics”—though he might have added government statistics. That skepticism is playing itself out in the current inflation debate.
Since peaking at 9.1% in June 2022, inflation fell sharply toward the Federal Reserve’s goal of 2% before plateauing above 3%, according to the consumer price index, or CPI, compiled by the U.S. Bureau of Labor Statistics. Other government price measures, including the Fed’s favored personal consumption expenditures price index, or PCE, from the Bureau of Economic Analysis, largely agree with the CPI. Presidential candidate Donald Trump, among others, doesn’t.
“They had inflation of—the real number, if you really get into the real number, it’s probably 40% or 50% when you add things up, when you don’t just put in the numbers that they want to hear,” the former president said at a June campaign event.
Casting doubt on government data finds receptive listeners, as Americans name high prices as the biggest threat to household finances.
It doesn’t help that inflation measures involve complex calculations with names like “hedonic adjustments,” and that even academics use four-letter expletives in arguing their cases.
Where economists see Adam Smith’s invisible hand at work, others see something more sinister. Recent reports of an $18 BigMac have fueled talk of pricing conspiracies.
The Fed is distrusted on the political left and right, with some calling it an “economic manipulator” that should be abolished. “America has a strong populist tradition,” former Fed Chairman Ben S. Bernanke writes in 21st Century Monetary Policy.
“Populists—from Andrew Jackson to, more recently, members of the Tea Party and Occupy Wall Street—have always been hostile to perceived concentrations of power in finance and government.”
That hostility has been present since the Bureau of Labor Statistics released the first national CPI, which included data going back to 1913, in February 1921. In a Page One editorial headlined “Deceptive Index Numbers,” The Wall Street Journal accused the BLS of using “Bolshevist calculations” to assume “an impossible minimum living wage of the lordly figure of $2,600 [around $45,000 today] a year.”
Further, it wrote, “a series of radical readjustments” in the index made it “look fishier than ever.” Updates in the CPI mix, in fact, keep it relevant. Cars and radios, for instance, weren’t common enough to be included in the earliest years. Straw hats were prominently represented in 1919 before falling from fashion.
Some items have remained. Back in 1913, round steak cost 22.3 cents a pound, which converts to about $7 today—a bargain, compared with the actual U.S. average of $8.25 in May. Butter, though, cost 38.3 cents a pound then—the equivalent of around $12 today—versus the $4.59May average.
Despite its “Bolshevist calculations,” the CPI became indispensable to business.
In 1922, Barron’s used it to show how prices had fallen from inflationary postwar highs, concluding that further business recovery “is fairly assured.” American’s changing spending is seen in comparing today’s expenditures with the Great Depression.
From 1935-39, food represented 33.9% of an average household’s expenses; it accounts for just 13% today. Apparel ate up 11% of a Depression era paycheck; it’s 2.6% today. Shelter costs, however, have risen from 33.7% to 36.1%; and medical care is up from 4% to 7.9%.
The bureau compiles the CPI from surveys of metro-area businesses and households, collecting about 94,000 prices and 8,000 rental-housing-unit quotes a month. Indexes are compiled by category, region, and in variations such as the “sticky price,” or core measure used by both the CPI and PCE that excludes food and energy prices.
Excluding food and energy seems counterintuitive, since they make up a large chunk of expenditures. But commodities are susceptible to price disturbances outside of normal supply and demand. Think of the oil embargo of 1973, which tripled prices in months, or the spike in grain prices caused by Russia’s 2022 invasion of Ukraine. Central banks lack tools to address such shocks.
The CPI shelter-costs calculation, too, draws scrutiny. It uses rent for renter-occupied housing, and implicit rent for owner-occupied units.
Why not consider ownership costs? Owned housing units, along with mortgage interest, property taxes, and improvements are considered capital goods— rather than consumption items.
Perhaps the most controversial practice is known as hedonic adjustment. If the quality of a good goes up—say, a PC gets a better processor and more memory—its price can go up, too, without adding to inflation as measured by the CPI. “It’s a con,” wrote Bill Gross in 2004, claiming hedonic adjustments lowered annual inflation by as much as 1%.
The Fed prefers the PCE mainly because it responds to changes in spending habits more quickly than the CPI. The PCE tends to track the CPI, with a slightly lower rate of inflation.
The core PCE rose 2.6% in May—in line with expectations, and the lowest increase since 2021. Yields fell as some investors saw this as a sign the Fed may be ready to cut interest rates. Fed Chair Jerome Powell shot that down, saying he first needed to be sure he’s getting “a true reading on what is actually happening with underlying inflation.”
Don’t we all.
Source: Barron's
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