The method the government uses to track inflation through the Consumer Price Index is a decent gauge. It tracks the prices an ‘average person’ in America pays for a particular basket of goods. That said, there are a number of alternative inflation measures which may better capture the ultimate value of your money – now and in the future.
Perhaps an overly strict index isn’t the best choice?
What’s wrong with a basket of goods?
The strict definition of the goods basket in CPI might be a problem
Who among us is a ‘typical person’, who spends their money in the exact proportions as the average of all Americans? Well, no one… which opens up all inflation measures (not just the CPI) to complaints from someone.
These other measures might better match your own inflation, even if they don’t tell the overall story as well as CPI.
Chained CPI
If you don’t like the CPI, you probably won’t like the Chained Consumer Price Index.
Since people usually substitute away from goods as prices increase, the chained CPI incorporated this substitution into the index. That is, unlike the CPI the basket of goods isn’t fixed.
Consider the price of food. If you eat a lot of ground beef but the price increases, you might switch to ground pork or chicken. Multiply your effect over the economy and you get what the chained CPI is trying to measure.
The chained CPI lags the regular CPI by a bit because of the substitution. You can find it on FRED.
The PCEPI – Personal Consumption Expenditures Price Index
The PCEPI is an inflation measure (technically a deflator) based on just the Personal Consumption component of the Gross Domestic Product of the United States.
A common complaint about the CPI is that it understates year to year price changes. CPI actually tends to understate changes in price over longer ranges of time.
Since inflation should factor in when products are substituted and the PCE contains substitution by default, it is likely a better indicator to use over longer time periods. It’s often more fair to use the PCEPI to determine the cost of goods in the past.
You can find the PCE Price Index (like I do) on the St. Louis Fed website.
The Billion Prices Project
The BPP is a very interesting project from an inflation measurement standpoint.
It uses e-commerce to come up with a real time daily glimpse of a basket of goods online. It tracks prices online across many countries, and can watch how the relative prices of products shift when exchange rates vary.
When new places sell a product (and a new page is found), the index automatically factors the new seller into the index.
Check out the Billion Prices Project at MIT.
The Everyday Price Index
Think the CPI is weighted too heavily to big ticket items like cars, trips, building materials and technology? You aren’t alone, and you’re right in thinking that low-tech products have increased rapidly in price the last few years.
The American Institute for Economic Research agrees and took the idea to its logical conclusion. They only count items which the average American buys once a month or more. (Toothpaste in; computers out.)
“The index includes food and beverages, household energy products and services, other utilities, motor fuel, prescription drugs, child care fees, phone services, personal care products, and other goods and services purchased on a regular basis. “
Check out the AIER and the EPI.
Other Inflation Measures and Indices
There’s no shortage of indices compiled to track inflation (Big Mac Index, anyone?). A number of new indices and indicators also are constantly released. We just wanted to shine a spotlight on a few of the more interesting ones for your next inflation argument!
Which inflation measures do you like the best? Can you pick a favorite? Do you think the CPI under or overstates true inflation? Do you like the Big Mac Index?
I like my own personal estimate of inflation. By tracking my expenses I understand what the things I buy and need change in price. I was just talking with a co-worker about electricity bills in a hell hole we both lived in at some point of lives, but about 17 years apart. The electricity cost was about the same at the peak month for similar size homes.
The CPI is a tool which helps to track trends in our complicated economy. While not perfect, I have a hard time thinking of a better system. EPI misses the mark, while we may not need a new car, TV, roof etc “everyday,” these do represent things the avg consumer buys and amortizes over the life of the product and they tend to be “big ticket” items. Including only “everyday” purchases may help to explain why we feel inflation is higher, but it doesn’t describe true inflation.
What do you think of the billion prices project? Impressive display of technology or useful indicator?
I do like that it has been pretty good about ‘predicting’ the CPI, without all the expense of logging the CPI itself introduces.
Disagree that big ticket items offset everyday expenses, since big ticket items are amortized over such a long time (esp. when my grocery and electric bill make me have to get 10 years out of my car). My grocery expenditures are (now) seven times my outlay for automobiles. Also, the USG does have issues that would drive keeping the CPI conservative, and that they have had to “manage” the calculation the last 20 years to do so. I think EPI feels more correct … because it is.
Finding an inflation measure which hews closely to your life is the key. If you take a close look at the EPI, there was a time when the goods tracked actually grew at a slower pace than the CPI. It’s possible we get into that sort of point again in the cycle.
It always irks me when people say the governmet CPI figures are ‘wrong’ because they disagree with the methodology or they cite individual anecdotal points like how milk at their grocery store is up 50 cents in the past couple weeks.
As we can see there are many ways to measure inflation. I don’t think
any one of the methodologies is ‘right’ or ‘wrong’ but they’re just all a
little different. And they’are all just broad averages and of course peoples individual circumstances will vary.
The anecdotal points are annoying, but even still – there are some very big differences that make CPI pretty much worthless. Everything that is “necessary” or which has a pretty inelastic demand curve is going up in price far faster than everything else. Health care, prescription drugs, housing, and college costs are just some of many.
Retirees – and anyone with a high proportion of fixed-income sources, and limited expenses – are taking a licking. I mean, even if you beat 2% inflation by earning 4% a year, you’re still lagging behind food, energy, and health care costs. Those costs make up a huge proportion of expenditures for the poor and retired.
Retirees and the poor need shelter just as much as the next guy. Or, as has been popular in America, a car. While energy and food may be rising, the bigger ticket items are going lower, which help to offset the “everyday” items. Again, we shop regularly for food, not so much for a washer and dryer. This is why inflation feels higher than it really is. But reality is, take out our biases, and it isn’t as bad as it feels.
I think that some demographics probably will see sustained inflation, even when teasing out biases… in my head I’m thinking of a middle class suburban couple with multiple college aged children (heh – that’s a rough one). Medicine is usually more shielded from view, but I can see some groups getting hit hard by the specter of medical inflation.
For that perspective, CPI is pretty close to perfect – it measures a basket of goods bought by an average American (in average proportions), and does so in a repeatable manner.
That said, I like the ‘inflation competition’ we are seeing. For some people, these other measures might have a much better bead on their spending – so without tracking a budget, people can see “well, hey, necessities are rising at xxx%” or whatever. Of course, I agree the CPI gets way more flack than it deserves…
The measure of inflation that is most accurate for me is how much my monthly budget is impacted by the cost of fuel. When that goes up, as it has been for the past 6 months especially, the impact on my family is significant. When the ripples of higher energy costs go throughout our economy, it hurts even more.
I use the McDonald’s Dollar Menu. Yep, still a dollar = no inflation.
Seriously, though, the EPI looks more attractive for taking into account real life on the ground.
But… are more things coming off the menu? Are the ingredients changing? Haha… insidious inflation might still be replacing your ingredients!
now we are talking! This is a great post (and this is my first time here.. GREAT blog).
Thanks so much; you’ve got a nice site yourself!
Whatever index we use, the trendline is clear…. UP!
And the Fed is guaranteeing roughly 2% increases in the CPI for the foreseeable future…
Thats a good post. Everyone in such times would be attracted to know more about inflation.