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The Consumer Price Index (CPI) is a well-thought-out way to measure inflation from month to month, and to assign a number to it. The U.S. government has many, many reasons – in both fiscal policy and monetary policy – to measure inflation, so the Bureau of Labor Statistics (BLS) has created the Consumer Price Index (CPI) and the Producer Price Index (PPI).  There are various other indices to measure prices of raw materials (such as metals or chemicals) or to track the costs of specific items like gasoline or avocados or even the cost of renting an apartment in San Francisco). Most major countries around the world have some version of the Consumer Price Index.

I find it interesting that the European Central Bank doesn’t include the cost of owner-occupied housing in their Harmonised Index of Consumer Prices (HICP), because they consider buying a home to be an investment, not a cost of living. Also it’s interesting that the European HICP includes prices from rural areas, whereas the U.S. CPI only measures prices in urban areas. To some degree, all measures of inflation are artificial inventions created by statisticians and economists. These indices are either close to or far away from reality.

What is the difference between the CPI and the chained-CPI? What’s the best way to measure inflation?

I’ll say more below the orange biscuit of cream-cheesy deliciousness.

I have three points to make:

1) In the traditional (non-chained) CPI, we’re comparing apples with apples. You have a standard (albeit fictional) market basket of maybe 200 items, you check the prices in maybe 200 cities and everything is weighted and turned into statistics and when the calculations are done, the BLS announces that “the cost of living went up by 0.3% over last month (3.6% on an annual basis).” Maybe there was a drought in the corn states, so corn prices went up. There was a bumper crop of asparagus (from wherever-the-fuck that’s grown), so that price went down. Gasoline went up (so everything that had to be trucked to market went up a little). The value of the Peruvian currency (the sol) went down, so imported Peruvian grapes were cheaper. There are a zillion reasons the individual prices fluctuate in the different cities.

Maybe the price of buying or renting a house went down in Detroit and Atlanta, but went up in Boston and Salt Lake City, so the local CPIs might be a little higher here or there.

This is important: As long as you’re comparing exactly the same market basket in exactly the same cities over a period of time, you’re tracking the same prices for the same items. You’re comparing apples to apples and asparagus to asparagus and Boston to Boston. This way of measuring inflation makes a lot of sense to me.

Sometimes the BLS adjusts the market basket. People are buying digital cameras instead of film cameras. People are disconnecting their land lines and switching to cell phones. People have stopped buying horse-and-buggies and getting automobiles. Whatever or whenever. The index gets adjusted a little bit.

So that’s one method to figure out inflation. But on the other hand…

2) At some point, some economist said, “You know what? That market basket of goods isn’t the way real consumers buy things. They don’t buy 2 apples and a banana and a can of corn and half a pound of hamburger every single week. If lettuce is expensive, they’ll buy raw spinach instead. If lentils are cheaper than navy beans, people might buy lentils.”

That’s a good point. I went to the store on Friday and bought grapes at 99 cents a pound because that’s relatively cheap compared to two months ago when they were $2.50 a pound (I like grapes, but I won’t pay that much). The week of St. Patrick’s Day, I bought cabbage and corned beef because it was on sale. The day after Easter, I bought Easter candy at reduced prices. It was shaped like eggs and bunnies, but my mouth loves the taste of delicious chocolate of any shape.

So that chained-CPI idea makes sense to me, too. It’s closer to what happens in the real world. When toilet paper goes on sale, I buy enough to last a month or two. When grapes are cheap but apples are regular price, I buy grapes. I’m taking advantage of price fluctuations.

But the problem with the chained CPI is that it’s comparing apples to oranges.  Comparing Wheat Thins to Triscuits. Comparing hamburger to tuna. I understand the concept, but I think it’s designed to deliberately understate inflation.

3) Here’s where reality slaps you in the face and things get political. There are lots of people who have a Cost of Living Adjustment (COLA): from union contracts, pensions, food stamps, social security, and so on.  If politicians can figure out a way to understate inflation (via the chained CPI),then in the long run the government or companies will pay out less money (and it will hurt people who have a COLA adjustment, bit by bit).

That’s why I think chained-CPI can be justified (as an abstract economic concept) but it’s wrong (as a government-mandated COLA policy).

Personally, I think the two biggest sources of inflation are the cost of energy and the cost of health care. The way to keep inflation in check is move away from oil-based energy to renewable green energy. And to figure out how to remove the profit motive from health care. It’s oil and health care that are raising prices, not the price of hamburger or asparagus.

And that’s my opinion.

Originally posted to Dbug on Sun Apr 14, 2013 at 05:06 AM PDT.

Also republished by Social Security Defenders.

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