Inflation Then and Now

I’ve been on this stagflation kick, and a few readers haven’t shied away from calling me out on the official BLS CPI numbers.  This has sparked an intellectually interesting conversation, and a whole lot of mind-numbing research on my part in finding out how the CPI (Consumer Price Index, the government’s measure of inflation) is calculated and how this has changed over the years.

And it HAS changed over the years, with major changes in the methods in 1983 and 1998.  That isn’t what is up for debate LOL  The debate is whether those changes are a more accurate way of measuring inflation or just number manipulation to ensure we don’t see  inflation numbers like we did in the 1970s again.

These changes also mean people cannot compare today’s inflation numbers to the 1970s inflations numbers without adjusting for the changes (just as wages and prices get adjusted for inflation when comparing time periods).  To compare today’s inflation numbers the pre-1998 inflation numbers without the adjustment is apples-to-oranges.  To compare today’s inflation numbers to pre-1983 inflation numbers is apples-to-bananas.  That is why I posted that chart last week:

inflation calculation methods and differing numbers

If we use the pre-1983 numbers to compare today’s inflation to the inflation experienced in the late 1970s, we have to use the 11.6%, not the official 4% that gets used in news reports.  Otherwise, it would be like comparing minimum wage in the 1970s versus minimum wage today, without any adjustment.  Without the adjustment, you’d think minimum wage workers today make out like bandits at $5.85 per hour, as opposed to $1.25 per hour they used to make in the 70s.  Trust me, when I get my hourly check from work, I don’t feel very rich.

So just why did the government go and change the inflation calculation methods, anyway?  One argument is that it wasn’t an accurate reflection of true consumer behavior, which is why the substitution bias was introduced.  Yes, consumers DO substitute when the price of one thing gets too high.  The classic example is steak.  When steak gets too expensive people will forego the steak for something cheaper (the classic substitution is hamburger).  But figuring that into the CPI sort of masks the reason WHY people substitute.

Then there’s this strange thing called “price hedonics” which weights the price versus the perceived “quality” of an item.  Commenter Traciatim used the example of cars, and the other classic example is computers.  If you look at the price tags from earlier computers versus today’s computers, they haven’t changed much.  Yet according to the BLS’s numbers, computers have come down in price significantly.  Their rationale is that even if you pay the same price, you get a faster and better computer, so they have a complex mathmatical/statistical formula that says the price for a computer today is much less since you (theoretically) get more bang for your buck.

That’s the pro-changes argument in a nutshell and vastly simplified by me.  I am firmly in the cynical con-changes camp, and offer up four little words as a reason why the government changed the methods of calculating CPI: cost-of-living adjustments.  Social Security, disability (SSDI and VA), plus all the civilian government employees and the military all get their annual raises through cost-of-living adjustments.  If the inflations numbers aren’t as high, then the COLA isn’t as high.

If I want to indulge my truly cynical side, I could offer up another reason: No politician ever wants to be associated with double-digit inflation ever again.  But that would be hideously cynical of me, especially during a presidential election year.  But I digress … sorta.  Could y’all imagine the media feeding frenzy that would be going on if we still used the pre-1983 method of figuring inflation?

In the interest of equal air time for the opposing view, here is one blogger who doesn’t think the CPI numbers are manipulated.

The bottom line with inflation numbers is that they are different today than they were 25 years ago.  Whether you agree with the changes or not, we can at least agree on that much.  And I advance the notion that to compare inflation rates then and now, we have to use the same methods … so to compare today’s inflation to the 1970s, we need to go with that top line on the chart and say “Using pre-1983 methods of calculation, we are currently running 11.6% inflation which is comparable to the double-digit inflation rate of the 1970s stagflation period.” 

Let the CPI and inflation discussion continue …!