Why Inflation is Higher Than What the Government Reports

Why Inflation is Higher Than What the Government Reports

In the most recent report by the Bureau of Labor Statistics (BLS), the Consumer Price Index (CPI-U) recorded a 2.9 percent year-over-year increase in the 12 months ending in February.  The Core CPI-U, which eliminates the volatile food and energy sectors, rose by 2.3 percent year-over-year .  Despite these modest numbers there seems to be a widespread perception of higher inflation among the public. Is there a reason why perceived inflation is much higher than the actual BLS statistics? 

  • The impact of political influence. Starting in 1921, the BLS published annual CPI numbers. Over time, especially after WWII, the CPI began to be used more often for cost-of-living adjustments in labor contracts. Another popular use for the CPI was in determining the cost-of-living adjustment for Social Security recipients after legislation enacted in 1973 provided that payments to recipients keep up with inflation. According to economist Walter Williams, this made the CPI susceptible to political influence.  In particular, the Boskin Commission – appointed by the US Senate in 1995 – argued that the CPI should better reflect a consumer’s ability to substitute a less expensive good for a more expensive good, such as hamburger for steak.
  • Underestimating inflation. Beginning in 1999, the BLS began to use geometric weighting instead of arithmetic weighting.  This means that it gave a lower weighting to CPI components that were rising in price and a higher weighting to those items that were decreasing in price.  The BLS calculated that the shift to geometric pricing lowered the annual growth rate of the CPI by 0.3 percent, but other economists have calculated that it underestimated inflation by approximately 3.0 percent annually. 
  • Quantifying the quality of a good. The BLS also attempts to quantify the quality of a good.  If a good remained the same price but the quality improved, the BLS would calculate this as a price decrease.  With approximately 50 percent of the CPI comprised of products subject to quality adjustments, the BLS judgments on quality could significantly alter the inflation rate.  Pacific Investment Management Corporation (PIMCO) estimated that the Personal Consumption Expenditures Index – an inflation index similar to the CPI – was underestimated by 0.5-1.1 percent per year because of the use of hedonics and substitution. 

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