HOW THE FEDS CONCEAL INFLATION
(Economist Barry Elias provided invaluable aid in researching this column)
If the same methodology that was used in 1980 to chronicle the double digit inflation of that era were in use today, we would have an inflation rate of ten percent right now, according to Shadow Government Statistics. We are entering a massive era of stagflation which recalls to us our writing in Catastrophe, published two years ago, that “inflation may well be the enduring legacy of the Obama presidency.”
How does the federal government understate the inflation rate? Let us count the ways:
1. It excludes food and fuel costs from its rate of “core inflation.” Each month, the Federal Reserve calms national inflation fears by pointing to the low rate of core inflation, currently at an annual pace of just 2.1%. It reaffirms that the economy is meeting the goal set for it by the Fed of keeping core inflation around or below two percent.
Claiming that food and fuel are too unstable to be included in the inflation rate, it excludes precisely those areas in which inflation is felt most deeply. In the past year, the cost of commodities from corn to soybeans has doubled and the price of gasoline at the pump is one third higher than it was one year ago. The average American household budget devotes one-third of its cash to food and energy costs. Leaving these elements out of the inflation rate has no justification.
2. It substitutes less expensive products when prices rise When prices go up, the economists who generate the Consumer Price Index substitute less a expensive alternative product for the one that has risen in price. For example, if the cost of steak goes up, the CPI does not reflect the increase, but simply replaces steak with hamburger in computing the price index.
3. It excludes “hedonistic” products as price rises The Fed adjusts for price rises by dumbing down the luxury elements of the products whose price it measures. It might, for example, measure the price of cars without air conditioning as a way of avoiding reporting the increase in the cost of automobiles. Even when the luxury features cannot easily be removed from the product, the CPI economists assume that they are.
4. In averaging the price of different commodities, it uses a geometric — not an arithmetic mean. Since the geometric mean, which compares the square roots of product prices, comes out lower, it understates the rate of inflation. See the table below comparing two products’ prices a year apart:
|
Commodity
|
Start Price
|
Final Price
|
Expenditure Increase
|
|
A
|
$1.00
|
$1.00
|
$0.00
|
|
B
|
$1.00
|
$1.50
|
$0.50
|
|
Total Expenditure
|
$2.00
|
$2.50
|
$0.50
|
To the layman, an increase in total spending of 50 cents on a base of $2 would represent a 25% increase in price. But that uses the arithmetic mean.
The geometric mean compares the square root of (new price / original price) multiplied by the same for the other commodity. Using this method of calculation, the increase in price would only be 22.5%.
The CPI switched to geometric comparison in 1994. Neat huh?
But no matter how the federal economists bend and twist the data, most Americans realize that we are in for a massive bout of inflation.
And this inflation is dramatically different from the last hyper inflation of the late 70s and early 80s. That inflation was caused by too much money chasing too few products. To slow down the economy and tame price increases, the Fed raised interest rates. But this inflation has nothing to do with demand. Rather, it is caused by the upward push of costs like gasoline, taxes, food, health insurance, and, soon, interest rates. This cost-push increase in prices cannot be tamed by cooling off the economy, which is, in fact, so cool already that it is approaching zero growth.
Stagflation, which will get worse and worse, may be Obama’s real legacy to this country.
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