Skip to comments.Misconceptions about the CPI (FR Thread to Prove or Disprove CPI and Shadow Stats)(17page PDF file)
Posted on 04/15/2011 9:08:02 AM PDT by Uncle Miltie
Addressing misconceptions about the Consumer Price Index
A number of longstanding myths regarding the Consumer Price Index and its methods of construction continue to circulate; this article attempts to address some of the misconceptions, with an eye toward increasing public understanding of this key economic indicator.
The Consumer Price Index (CPI), published by the Bureau of Labor Statistics (BLS), has generated controversy throughout its history. A soon-to-be-published article by Marshall Reinsdorf and Jack Triplett discusses the many past reviews of the methods and data used in the CPIs construction.1 Beginning with an advisory committee appointed by the American Statistical Association in 1933,2 and continuing through the recent National Research Council panel chaired by Charles Schultze,3 panels and commissions have identified and discussed what is now a well-known set of issues affecting the measurement of consumer prices: consumer substitution behavior, change in the quality of products, the introduction of new types of goods and services, and the appearance of new categories of stores and new channels of product distribution. Given the large number of private and public uses of the CPI, and especially its important role in determining Federal Government revenues and payments, it is natural that each of those issues has been the subject of intense public attention.
Within the past several years....... (Etc.)
(Excerpt) Read more at bls.gov ...
I think we know the major proponents and opponents of the CPI here on FR. What I want to do here is to accumulate the Third Party, academic, philosophical, and economic records of arguments in favor or opposing the CPI as currently constructed, and especially whether Shadow Statistics is a more relevant data set.
Let's leave the emotions and personal attacks in the locker room, guys. We know how you point / counter-point each time this comes up. Let's have third parties weigh in.
It is critical to my personal and corporate decision making to determine the validity of the CPI and Shadow Stats. I don't have a dog in this fight, other than to truly understand the relative validity of each approach.
So, let's treat this as our Phd Econ class, and bring facts and arguments. Let's take the conversation up a level, and let's have this string stand as a representative of each camp's best data, proofs and arguments.
I'll moderate, if you don't mind, asking questions of both sides if I personally need clarification. Like I said, I don't have a dog in this hunt.
BusinessWeak opened a thread for discussion of this topic here. Feel free to bring this to the thread if it supports your position.
I don’t need the freakin’ government to tell me what inflation is doing. I see it every time I go to the gas pimp or grocery store.
Bring your friends, family, and arguments over here, dudes. Keep it FRiendly!
The BLS has attempted to defend against all the Shadow Stats arguments in the linked .pdf. Be sure in your posts that you can overcome their defenses if you wish to defend Shadow Stats.
Dude: We’ve seen that post a dozen times. Plus which, the BLS report to which the thread is linked attempts (and does a fair job) of debunking each of your points.
Please go read the BLS arguments, and bring something new.
So basically they’ve cooked the books. They’ve built their statistics on a foundation of shifting sand which makes them meaningless except in the context to provide political cover in case we need to print more money.
Hey look! We printed more money to pay for excessive government, but your money has the same value!- If you don’t mind eating hamburger instead of steak.
Oh, and ignore the rising food and gas prices, it doesn’t matter.
“September 04, 2008
I’ve yet to find someone who has been able to reproduce the claims made by Shadow Government Statistics about the extent to which government agencies are grossly misreporting the U.S. inflation rate. Apparently, neither has the Bureau of Labor Statistics, as detailed in an article by BLS economists John Greenlees and Robert McClelland in the latest issue of Monthly Labor Review.
First, some of the bolder claims by Shadowstats:
The Boskin/Greenspan argument was that when steak got too expensive, the consumer would substitute hamburger for the steak, and that the inflation measure should reflect the costs tied to buying hamburger versus steak, instead of steak versus steak. Of course, replacing hamburger for steak in the calculations would reduce the inflation rate, but it represented the rate of inflation in terms of maintaining a declining standard of living. Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that....
The BLS initially did not institute a new CPI measurement using a variable-basket of goods that allowed substitution of hamburger for steak, but rather tried to approximate the effect by changing the weighting of goods in the CPI fixed basket. Over a period of several years, straight arithmetic weighting of the CPI components was shifted to a geometric weighting. The Boskin/Greenspan benefit of a geometric weighting was that it automatically gave a lower weighting to CPI components that were rising in price, and a higher weighting to those items dropping in price.
Once the system had been shifted fully to geometric weighting, the net effect was to reduce reported CPI on an annual, or year-over-year basis, by 2.7% from what it would have been based on the traditional weighting methodology. The results have been dramatic. The compounding effect since the early-1990s has reduced annual cost of living adjustments in social security by more than a third.
And here’s the response by Greenlees and McClelland:
To begin, it must be stated unequivocally that the BLS does not assume that consumers substitute hamburger for steak. Neither the CPI-U, nor the CPI-W used for wage and benefit indexation, allows for substitution between steak and hamburger, which are in different CPI item categories. Instead, the BLS uses a formula that implicitly assumes a degree of substitution among the close substitutes within an item-area component of the index. As an example, consumers are assumed to respond to price variations among the different items found within the category “apples in Chicago.” Other examples are “ground beef in Chicago,” “beefsteaks in Chicago,” and “eggs in Boston”....
The quantitative impact of the CPI’s use of the geometric mean formula also has been grossly overstated by some, with one estimate exceeding 3 percent per year. It is difficult to identify real-world circumstances under which geometric mean and Laspeyres indexes could differ by such a large amount. The two index formulas will give the same answer whenever the prices used in an index all change by the same percentage. The bigger the differences in price changes, the more the Laspeyres index will tend to exceed the geometric mean. For the growth rate of the Laspeyres index to exceed the growth rate of a geometric mean index by 3 percentage points, however, the differences in individual price changes have to be quite large.
To see this point, consider another very simplified example. Suppose that the CPI sample for ice cream and related products in Boston consisted only of an equal number of prices for ice cream and frozen yogurt and that, between one year and the next, all the prices of ice cream in Boston rose by 8.6 percent while all the frozen yogurt prices fell by 4.2 percent. In that case, the geometric mean estimate of overall annual price change would be 2.0 percent, only slightly less than the Laspeyres estimate of about 2.2%. In order to come up with a difference of 3 index points, one has to assume a much more dramatic divergence between ice cream and frozen yogurt prices than the one hypothesized. For example, if ice cream prices rose 30 percent in one year, while frozen yogurt prices fell by 20 percent, the overall geometric mean index would still rise by 2 percent, but the Laspeyres index would rise 5 percent, for a difference of 3 index points. However, such a large annual divergence would be quite uncommon within CPI basic indexes— between ice cream and yogurt, between types of candy and gum, between types of noncarbonated juices, or between varieties of ground beef. Moreover, for a 3-percentage-point divergence to continue year after year, the divergence between the individual component prices would have to continue to widen. For example, if, by contrast, during the next year ice cream prices increased by the same amount as frozen yogurt prices, then the two index formulas would give the same inflation estimate for that year. Although such a divergence might plausibly occur in one component for 1 year, it is beyond belief that such sharply divergent price behavior would continue year after year across the whole range of CPI item-area components.
Finally, and most importantly, there is rigorous empirical evidence on the actual quantitative impact of the geometric mean formula, because the BLS has continued to calculate Laspeyres indexes for all CPI basic indexes on an experimental basis for comparison with the official index. These experimental indexes show that the geometric mean led to an overall decrease in CPI growth of about 0.28 percentage point per year over the period from December 1999 to December 2004, close to the original BLS prediction that the impact would be approximately 0.20 percentage point per year.
There’s much more in the BLS article on this and related questions such as hedonic price adjustment and owner’s equivalent rent.
Why do people continue to give credibility to an operation like Shadowstats? Now that’s something that I’d like to hear explained.”
|Chronology of changes in the Consumer Price Index
Began publication of separate indexes for 32 cities (1919)
Collected prices in central cities periodically.
Developed weights from a study that BLS conducted in 1917-19 of family expenditures in 92 industrial centers
Reflected the relative importance of goods and services purchased by consumers.
Collected prices for major groups: Food, clothing, rent, fuels, house furnishings, and miscellaneous
Limited pricing to items selected in advance to represent their categories
Began regular publication of a national index, the U.S. city average (1921):
Based index on an unweighted average of the city indexes.
Estimated U.S. city average back to 1913, using food prices only.
The 1940 CPI revision: the first comprehensive revision
Used weights based on 1934-36 study of consumer expenditures
Collected prices in the 34 largest cities
Implemented a weighted average of cities for the U.S. city average CPI
Improvements made between the 1940 and 1953 revisions
During World War II:
Discontinued the pricing of unavailable items, such as new cars and household appliances
Increased the weight of other items, including automobile repair and public transportation
Adjusted weights in seven cities using 1947 and 1949 survey of consumer expenditures
Adjusted weights for the 1950 census
Adjusted rent index to remove new unit bias caused by rent control
Added new items to the list of covered items, including frozen foods and televisions
The 1953 CPI revision: the second comprehensive revision
Used weights from a 1950 expenditure survey conducted in central cities and attached urbanized areas
Refined the target population to include urban wage earner and clerical worker families
Added a sample of medium and small cities
Updated the list of items that the index covered, adding restaurant meals
Added new sources of price data
Improved pricing and calculation methods
The 1964 CPI revision: the third comprehensive revision
Based weights on 1960-61 expenditure patterns in metropolitan areas
Added single-person households to target population: urban wage earner and clerical worker households
Extended pricing to the suburbs of sampled metropolitan areas
Updated the sample of cities, goods and services, and retail stores and service establishments
Improvements made between the 1964 and 1978 revisions
Made quality adjustments for new vehicles at model changeover
Improved treatment of seasonal items
The 1978 CPI revision: the fourth comprehensive revision
Added a new Consumer Price Index: the CPI for All Urban Consumers, or the CPI-U
Renamed the older CPI as the CPI for Urban Wage Earners and Clerical Workers, or the CPI-W
Used weights from a 1972-73 survey of consumer expenditures and the 1970 census
Expanded the sample to 85 areas
Increased minimum pricing frequency from quarterly to bimonthly
Implemented monthly pricing in the five largest areas
Introduced probability sampling methods at all stages of CPI sampling:
Used probability selection methods to select the CPI sample items within stores
Eliminated the list of eligible items as virtually all consumer items became eligible for pricing
Introduced checklists that define each category of spending
Developed estimates of the CPIs sampling error and optimal sample allocation to minimize that error
Improvements made between the 1978 and 1987 revisions
Began outlet and item sample rotation (1981):
Began systematic replacement of outlets and their item samples between major revisions
Implemented new Point-of-Purchase Survey (POPS)
Selected retail outlets with probability proportional to consumer spending therein
Eliminated reliance on outdated secondary-source sampling frames
Began rotating outlet and item samples every 5 years
Began rotating one-fifth of the CPI pricing areas each year
Introduced rental equivalence concept (January 1983 for the CPI-U; January 1985 for the CPI-W):
Introduced the flow-of-services method, which removes the investment component from homeowner indexes
Discontinued the asset-price approach, which treated the purchase of a home as a consumer good
The 1987 CPI revision: the fifth comprehensive revision
Used weights from the 1982-84 Consumer Expenditure Survey and the 1980 census
Updated samples of items, outlets, and areas
Redesigned the CPI housing survey
Improved sampling, data collection, data processing, and statistical estimation methods
Initiated more efficient sample design and sample allocation
Introduced techniques to make CPI production and calculation more efficient
Improvements made between the 1987 and 1998 revisions
Improved the housing estimator to account for the aging of the sample housing units
Improved the handling of new models of vehicles and other goods
Implemented new sample procedures to prevent overweighting items whose prices are likely to rise
Improved seasonal adjustment methods
Initiated a single hospital services item stratum with a treatment-oriented item definition:
Discontinued pricing of the inputs to the index for hospital services
The 1998 CPI revision: the sixth comprehensive revision
Weights from the 1993-95 Consumer Expenditure Survey and the 1990 census
Updated geographic and housing samples
Extensively revised item classification system
Implemented new housing index estimation system
Used computer-assisted data collection
Added the Telephone Point-of-Purchase Survey (TPOPS):
Allows rotation of outlet and item samples by item category and geographic area, rather than by area alone
Initiated a new housing survey based on the 1990 census (January 1999):
Estimated price change for owners equivalent rent directly from rents
Began using a geometric mean formula for most basic indexes (January 1999):
Mitigates lower-level substitution bias
Reflects shifts in consumer spending within item categories as relative prices change
Published the CPI-U Research Series
Featured backcastings of all CPI method changes to 1978
Provided revision in cases of methodology change
Improvements since the 1998 revision
Extended the use of hedonic regression to estimate the value of items changing in quality
Directed replacement of sample items in the personal computer and other categories, to keep samples current
Implemented 4-year outlet rotation to replace the 5-year scheme
Began within-outlet item rotation for prescription drugs and other item categories
Implemented biennial weight updates (January 2002):
Separated weight updates from major revisions to keep weights as current as possible
(Weights used in 2002-2003 were based on the 1999-2000 Consumer Expenditure Survey; weights used in
2004-05 were based on the 2001-02 Consumer Expenditure Survey; weights used in 2006-07 were based on
the 2003-04 Consumer Expenditure Survey.)
Increased sample size of the Consumer Expenditure Survey, so that CPI weights can be based on just 2 years of data from expenditure surveys 2 and 3 years previous
Added the Chained Consumer Price Index for All Urban Consumers (C-CPI-U) (August 2002):
Uses more advanced superlative index formula (the Tornqvist formula)
Corrects upper-level substitution bias
Began computer-assisted data collection for the Commodities and Services Survey (20022003)
Expanded collection of price data to all business days of the month
Began publishing indexes to three decimal places (Jan. 2007)
You can perform a ineternet search on “Shadow Stats”+”Hedonic” and get some get hits.
What Williams presents on his website and what he espouses in the media are not the same, he ALWAYS advocates his political ideology in the media.
One of the first truly comprehensive critiques of Williams CPI method is here:
September 04, 2008
Williams presented his repsonse to his critics (and specifically the econobrowser critique) a week later in regards to the topic of your post here:
Response to BLS Article on CPI Misconceptions
JOHN WILLIAMS SHADOW GOVERNMENT STATISTICS
September 10, 2008
ShadowStats.com Response to BLS Article on CPI Misconceptions
Reading about the Boskin Commission can make your brain fry and kill your soul, so be warned.
Here is one link regarding the little talked about CPI-RS, one of the effects of the Boskin Commission that turns Williams face red when asked about it:
Men on the Boskin Commission had some doubts about the CPI a decade after the Commission’s final report and implementation,
former member Robert Gordon of Northwestern
The Boskin Commission Report:
A Retrospective One Decade Later*
Robert J. Gordon
"Now you can believe there was a housing bubble, or you can believe that Shadow Stats is trustworthy, but if you believe both you're delusional. Personally, I believe there was a housing bubble and Shadow Stats is full of B.S."
Not intended as a thread hijack but do you know why Toddsterpatriot got banned? I was trying to pin him here for input.
Staying Neutral on Inflation vs. Deflaton
By James Kostohryz Sep 16, 2009 4:30 pm
Use the core CPI as your guide.
Theres been a heated debate in the financial press regarding the prospects for hyperinflation or deflation, with most pundits usually siding strongly with one camp or the other. Nowhere has this debate been more intense than within Minyanville.
I want to go on record saying that I definitely side with neither.
Ive been on record several times debunking the notion of hyperinflation or a dollar collapse anytime in the near future. However, Ive also been on record many times rejecting the doomsday scenarios of the deflationists.
Framing the Debate
Part of the problem with this debate rests in defining what these various terms mean. For example, I cant recall a single prophet of dollar doom or hyperinflation maven make a specific prediction citing a number or numerical range.
Thus, if the CPI were to rise above 10% per annum, I have little doubt that the mavens of hyperinflation will be declaring victory. And if the US dollar index were to decline another 10% or so, I have little doubt that the prophets of dollar doom with be loudly celebrating.
Similarly, the doomsday deflationists are equally vague in their forecasts. As long as the headline CPI stays below 0%, the doomsday deflationists will likely continue to declare victory.
This will not do. Forecasters need to define what theyre forecasting and be specific about their predictions. For example, the term hyperinflation doesnt have a specific numeric definition. However, various textbooks and other authoritative sources state that the minimum inflation rate that would qualify as hyperinflation would be over 100% per annum. Indeed, most sources that attempt to define hyperinflation cite monthly rates of 20% at minimum.
Similarly, to speak of a 10% or even 20% decline in the value of the US dollar — relative to a particular currency or a basket of currencies — as a collapse is nonsense.
Because the vast majority of the US economy is made up services and other non-tradeables, such a decline in the value of the US dollar would hardly be felt at all at the consumer price level.
Furthermore, such a decline would actually be quite positive for the US economy, as it would contribute to the lowering of the current account deficit — a problem that is at the heart of many important economic problems that the US faces, including excess indebtedness, sluggish job growth, and income inequality.
So a 10% to 20% decline in the foreign exchange value of the US dollar is hardly something that should generate the sort of panic that prophets of dollar doom have been attempting to incite — rather it would be something to be welcomed.
What about the doomsday deflationists? Theyre similarly vague in their predictions.
Admittedly, Ive heard few speak of hyper-deflation. So presumably, any inflation rate below 0% would satisfy their criteria.
However, this will also not do. Predictions of deflation need to be specific. For example, many in the deflation camp seem to view todays CPI figure of -1.5% as confirmation of their views regarding deflation.
However, what should we make of the fact that the core CPI — which encompasses the vast majority of goods and services — is still rising at a +1.4% per annum pace?
The Ideological Mindset
The truth of the matter is that many of the most ardent participants in the debate on inflation versus deflation tend to exhibit an ideological mindset.
There are several traits that tend to characterize such a mindset.
1. They tend to see things in terms of extremes — as black or white; all or nothing.
2. They tend to disregard empirical data, or to explain away the data thats not favorable to their point of view.
Let me cite some examples: A few years ago, the ideologues of hyperinflation were ardently arguing that despite the fact that the CPI was not rising, there really was inflation. One statistic they liked to cite was the growth in the money supply.
The funny thing is that ever since the growth in the various money-supply aggregates started to decelerate — and even contract in some cases — the ideologues of inflation stopped citing this metric.
Similarly, the ideologues of inflation constantly used to cite asset price inflation in property values and stock prices as evidence that there really was inflation, despite the fact that there was little or none reflected in the CPI.
However, strangely enough, in the last couple of years since property values and the stock market have been falling, the ideologues of hyperinflation have apparently suffered a case of amnesia and no longer seem to think those metrics are of any importance.
Indeed, when all else fails and the ideologues of hyperinflation are unable to find any empirical support for their claims, they tend to resort to citing highly questionable alternative statistics such as those concocted by Shadowstats.
Despite clear evidence of flat to falling consumer prices and collapsing asset prices, the ideologues of hyperinflation adamantly insist that there really is significant inflation, but the evil government is hiding it from us.
How do you have a constructive argument with people that either refuse to argue on the basis of empirical statistical data or that simply make up their own data?
Similarly, the advocates of deflation have had a bonanza in the past year citing falling stock prices and property values as evidence of massive deflation. Yet, I havent been hearing any of these very pundits talking about inflation rather than deflation now that stock prices are exploding and property values are rebounding.
And again, I dont see many of the ideologies of deflation acknowledging that the core CPI has never once reflected deflation during the recent crisis.
My Own Position
So, let me make my own position clear.
I believe that the core CPI is, in general, the best (although not the only) metric of inflation to monitor given the fact that food and energy prices tend to be volatile. Furthermore, food and energy prices are often driven more by localized supply-side resource constraints than the sort of generalized demand-pull dynamics characteristic of a truly inflationary environment.
Its my expectation that price levels, as defined by the core CPI, will remain within a range of 1.00% to 5.00% for the foreseeable future. Furthermore, its my expectation that disinflationary momentum is probably bottoming out, and that in the short to medium term, core inflation will tend to revert toward its recent norm between 2.0% and 3.5%.
Exactly how much core inflation rebounds from its current level of +1.4% depends entirely on the strength of the rebound in global growth. Liquidity is relatively abundant; therefore a stronger-than-expected global growth spike that puts pressure on certain short-term-supply-constrained goods and services such as natural resource commodities is certainly possible.
However, even in such a scenario, massive overcapacity in most industries, coupled with widespread unemployment, will tend to put an upper lid on any generalized inflation that would propel the core CPI above 5%.
Hyperinflation, although a theoretical possibility that cant be ruled out in the long term, is an extremely remote possibility in the short to medium term (defined as the next two years).
In terms that might be familiar to fans of the Austrian school, under current circumstances, excess liquidity combined with a surge in aggregate GDP growth (characterized by growth differentials among sectors of the economy) may cause relative price distortions and various concomitant ills. However, its unlikely to cause aggregate level hyperinflation.
Disinflation is the term I use most often to describe the economic environment with respect to aggregate prices during the past three decades, including the past year. And further disinflation is certainly a possibility in an environment of weaker-than-expected global growth.
However, massive fiscal and monetary stimulus in the US and elsewhere around the world will also put a floor on the extent of any deflation.
Governments and central banks in the US and around the world have considerable ability through a whole arsenal of measures to prevent deflation and its evident from the policy responses of the past year that officials around the world are determined to employ whatever monetary and/or fiscal mechanisms necessary to prevent a severe deflationary scenario analogous to the Great Depression.
Thus, for this reason, and the stickiness of modest inflationary expectations that have been ingrained in the psychology of the US population, core CPI inflation is unlikely to dip far below 0% in the foreseeable future.
It’s my expectation that disinflationary and deflationary pressures are subsiding and are quite likely to have bottomed out for the foreseeable future.
In particular, positive global growth surprises and concomitantly recovering asset prices are likely to create pockets of modest price increases in some sectors of the economy, which should be reflected in a reversion of aggregate core CPI inflation to recent historical norms between 2.5 and 3.5%.
However, because of massive overcapacity, unemployment, and the stickiness of inflationary expectations, a spike in core inflation above a modest 5.00% is unlikely, even if for no other reason than the fact that bond vigilante-ism would cause a spike in interest rates that would kill the incipient economic recovery, and with it, any major momentum in demand-side inflationary pressures.
In the end, the extremely heated debate between the mavens of hyperinflation and the doomsday deflationists is probably nothing more than a great deal of sound and fury signifying nothing.
Prce the housing bubble in physical gold and you come to the same conclusion, “”Now you can believe there was a housing bubble, or you can believe that market pricing of gold denominated in US Dollars is trustworthy, but if you believe both you’re delusional.”
I can’t find the US property priced in Gold blog post, so here’s a UK property priced in gold blog post and a Aussie property priced in gold blog post:
Property Priced in Gold
Posted on 13 April 2011 by BenM
When priced in gold property prices are down 69% from their peak in 2007
Property prices may only be down 14% when priced in British Pounds, however when priced in real money i.e. gold, we see that property prices are actually down 69% from their peak in the summer of 2007.
Good graphs and arguments here:
M3 is back
We did some sleuthing and data extraction and put M3 back together from various weekly Federal Reserve reports that are still available.
1.The formula we’re using has five 9s correlation to the original data back to 1980.
2.There is only one missing element that is apparently no longer available (Eurodollars) and an adjustment has been applied to generate it. Its only about 3% of total M3 so should not have a material effect on the total.
Here is our article on M3b, which details our work and notes the sources for the data. Note that as of Nov. 10, 2006 the Eurodollar estimation formula has changed - see the article for details.
John Williams monthly reconstruction of M3 is here. Ours tends to be more volatile than his, partly because it’s weekly and partly because of our differences in calculating the repo and Eurodollar component of M3.
Finally and to put M3 into proper perspective with inflation (as measured by CPI without lies), the M3 and M2 strong inflation link is virtually unquestionable. The longer term inflation picture is clear, although M2 shows a pause and likely temporary disinflation as of 2008. Certain bloggers are incorrect and have continually avoided these facts and the linked chart.
Tuesday, January 5, 2010
No Virginia, the Government Isn’t Manipulating Economic Statistics
“If the blue line on the shadowstats graph were the correct inflation measure, bond yields would be at least 400 basis points higher. Why? If shadow stats were correct, then bond investors would have been losing money for most of the 2001-2008 period because inflation was higher than the stated interest rate on the 10-year Treasury bond. Simply put, investors would not put up with that and instead would have sent yields far higher for the last decade. Yet they did not. That tells us that Shadow stats CPI number is wrong.”
(Frankly, I think it is entirely possible that bond investors actually did lose money for most of the 2001 - 2008 period.....The human herding instinct and is strong)
Official US Deficit Put At Staggering $202 Trillion
Posted by EU Times on Aug 25th, 2010 // 7 Comments
The Congressional Budget Office (CBO) forecasts the U.S. budget deficit will hit $1.3 trillion this year. An astronomical figure, to be sure, but thats lower than was projected in March. Its also less than last years record $1.41 trillion deficit, which was close to 10% of GDP.
And, thats the good news.
As the deficit grows so does the national debt, which is currently more than $13.3 trillion, according to official figures.
But the situation is actually much, much worse, according to Boston University economics professor Laurence Kotlikoff.
Forget the official debt, he tells Aaron in this clip. The real deficit including non-budgetary items like unfunded liabilities of Medicare, Medicaid, Social Security and the defense budget is actually $202 trillion, the professor and author calculates; or 15 times the official numbers.
Congress has engaged in Enron accounting, says Kotlikoff, who recently penned an op-ed for Bloomberg entitled: The U.S. Is Bankrupt and We Dont Even Know It.
Yet, the debt market continues to have an insatiable appetite for U.S. Treasuries; heading into Mondays session, the yield on the 30-year Treasury bond (which moves in opposition to its price) was at its lowest level since April 2009.
Kotlikoff says thats because the market is focused on the mole hill of official debt. In time, the U.S. will have a major inflation problem to rival that of Germanys post World War I Weimar Republic, he predicts. We have to think about the fact that unless the government gets its fiscal act in order were going to have the government printing lots and lots money to pay these enormous bills that are coming due over time.
America is in need of major reform of the health-care, retirement, tax and financial system, Kotlikoff continues. We need (to perform) heart surgery on this economy, not putting on more band-aids which is what weve been doing.
Barring that, your hard-earned dollars will soon be worthless, he declares.
Bringing Professor Gordon’s synopsis to the fore:
The Boskin Commission Report: A Retrospective One Decade Later*
This paper provides a retrospective on the 1996 Boskin Commission Report, Toward a More Accurate Measure of the Cost of Living, and its famous estimate that the CPI in 1995-96 was upward biased by 1.1 percent per year. The paper summarizes the reports methods, findings,and recommendations, and then reviews the comments and criticisms that appeared soon after the Report was issued. Changes in the CPI are summarized and assessed, as is recent research on related issues. The paper sharply distinguishes two questions. First, with what we know
now, what should the Commission have concluded about CPI bias in 1995-96?
Second, what is the bias now after the many improvements introduced into the CPI since the Commissions Report?
About the first question, my own recent research on apparel and rental housing indicates a substantial downward bias in the CPI over much of the twentieth century,diminishing in size after 1985. Incorporating these findings into the Boskin matrix would reduce its 0.6 percent annual upward bias due to quality change and new products to a smaller
0.4 percent bias. However, this is more than offset by the stunning discrepancy over 2000-06 in the chain-weighted C-CPI-U compared to the traditional CPI-U, indicating that the Commission greatly understated the magnitude of upper-level substitution bias. This retrospective evaluation suggests that the Boskin bias estimate for 1995-96 should have been 1.2 to 1.3 percent, not 1.1 percent.
Current upward bias in the CPI is estimated to have declined from the revised 1.2-1.3 percent in the Boskin era to about 0.8 percent today. Yet the Boskin report, like most
contemporary studies of quality change, failed to place sufficient value on the value of new products and on increased longevity. Allowing for these, todays bias is at least 1.0 percent per year or perhaps even higher.
Keywords: inflation, price measurement, substitution bias, quality change, new products, medical care
JEL Codes: I1, I11
Robert J. Gordon
Department of Economics, Northwestern University
Evanston IL 60208-2600
Can anyone summarize the above to any more than:
I may have missed your post in which you parry the BLS report at the top. Please direct me to it.
Also, please see the Northwestern Professor’s post in which he believes CPI remains overstated, and prove him wrong.
I’m open to the arguments, I just need to see them plainly address the rebuttals.
A very interesting read. I will quickly though disagree with the report on one critical matter:::
There is no universe in which Yogurt is a reasonable substitution for Chocolate Ice Cream.
Thanks for the into. Well what do you know, what goes around does sometimes actually come around! He’s been skirting the edge for a long time.
It makes sense to exclude extremely volatile items from Core CPI, as it would make it difficult to evaluate from month to month or Y-o-Y, whether the spike or fall in market prices of energy and food staples are temporary (due to crop drought or weather anomalies, geological conditions, geopolitical upheaval(s), industrial accident(s) etc.) or more permanent developments. The good thing is, that if energy cost is more "permanent" (let's say, stays at a "new normal" level for 3-6 months. it tends to seep into and be reflected in the prices of consumer products (including food) due to costs associated with production and delivery of such products...
In other words, we'll see "permanent" cost increase/decrease of generally volatile products reflected in Core CPI anyway, with some lag, after it's incorporated in the cost of the products or service, but the Core line will be smoothed over period of time, rather than sharp spike up or down or non-Core index.
Another reason it makes sense to exclude food prices from non-Core CPI is that generally they does not comprise a large percentage of household expenditures (generally, the lower the household income the more it's affected by food prices). Food and energy prices are also varied widely depending on where household is located, rural or urban areas, cities and states. However, along with gasoline (part of energy cost), it's one of the most visible and comparable costs for the U.S. households, so it generates the most heated and emotional complaints about "inflation". Food is also the most likely subject to "hedonic" substitution or even [temporary?] exclusion from the people's diet (BTW, dog/cat/pets food maybe a notable exception from this but I believe that it doesn't quite affect the CPI so it's irrelevant for this discussion).
It makes sense to use and periodically adjust "hedonic" regression / substitution, or we would still be working with the cost of buggy whips and costs of cleaning up horse manure from the streets. Yes, it's open to some political biases and influences, but likely less than generally suspected.
Buying generic label cereals or canned food, using bicycle, motorcycle, more efficient car or carpool, for example, are forms of hedonic substitution that are commonly practiced, but might be difficult to reflect in index without detailed data measuring these on a regular basis. Also, technology is a relatively constant disinflationary force, so giving it a higher weighting in the index would tend to pull index down.
Depending on the mix of the items in the BLS basket relative to what we tend to purchase (as a percentage of our income or costs) we will all see the different "realities" of COL... in other words, to people it's subjective and personal, while BLS is attempting to reflect the "average" CPI.
Also, we should not forget that recent droughts in the U.S., Australia, Africa, lingering long-term fiscal and monetary problems in certain EU countries (PIIGS) and dangerous political instability in Africa and Middle East, along with misguided politically motivated subsidies and "green" / environmental policies (not just in the U.S) have sent prices of food staples and energy (particularly oil) sharply higher in recent months. Add to that the huge inflation in China and India (and less relevant, in Brazil) which for years have been exporting deflation but are now starting to export [relative] inflation, and that the U.S. is just now coming out from the Great Recession and sharp disinflation (from about H2 of 2007 through 2010), and some inflation in the recovery ought to be expected.
BLS is doing a pretty good job of collecting data, and decent job of comprising and analyzing index, and separating Core from non-Core components. That said, no system is perfect and would satisfy everyone. Given that the data points are detailed in BLS reports, anyone can "personalize" their own "basket" of items and index it based on the weighting they want to attribute to each item, as they most affect the author of the index.
As long as we don't try to compare the today's cost of the "basket of apples" with the last year's cost of the "basket of oranges," we should do fine in proving just about anything we want, from our own view on price inflation/deflation.
There are credible attempts to create other indices that measure "price inflation" or consumer cost. Here is the most interesting recent one - MIT's BPP (Billion Prices Project) at http://bpp.mit.edu/daily-price-indexes/?country=USA
These indexes are designed to provide real-time information on major inflation trends, not to forecast official inflation announcements. We are constantly adding new categories of goods, but we do not cover 100% of CPI goods and services. The price of services, in particular, are not easy to find online and therefore are not included in our statistics. It's a set of interactive charts of Daily Online Price Index, Annual Inflation and Monthly Inflation. Keep in mind the differences from BLS CPI, but it's exactly why it may attract some people who are suspicious about BLS CPI - it only uses online price data, data is NOT "seasonally" adjusted, BPP includes the food prices but doesn't include energy prices.
Both CPI and BPP were up significantly in the last couple of months, but not much on Y-o-Y basis.
Some references that may be of interest:
From Why inflation hurts more than it did 30 years ago | Inflation hurts more than it did 30 years ago for Americans stuck with flat income - AP via Breitbart, 2011 March 18
Back in the '80's, the money people made typically more than made up for high inflation. In 1981, banks would pay nearly 16 percent on a six-month CD. And workers typically got pay raises to match their higher living costs. No more. Over the 12 months that ended in February, consumer prices increased just 2.1 percent. Yet wages for many people have risen even less - if they're not actually frozen. Social Security recipients have gone two straight years with no increase in benefits. Money market rates? You need a magnifying glass to find them. That's why even moderate inflation hurts more now. And it's why if food and gas prices lift inflation even slightly above current rates, consumer spending could weaken and slow the economy. ..... < snip >
Inflation spooked the nation in the early 1980s. It surged and kept rising until it topped 13 percent. These days, inflation is much lower. Yet to many Americans, it feels worse now. And for a good reason: Their income has been even flatter than inflation.
Back in the '80's, the money people made typically more than made up for high inflation. In 1981, banks would pay nearly 16 percent on a six-month CD. And workers typically got pay raises to match their higher living costs. No more.
Over the 12 months that ended in February, consumer prices increased just 2.1 percent. Yet wages for many people have risen even less - if they're not actually frozen.
Social Security recipients have gone two straight years with no increase in benefits. Money market rates? You need a magnifying glass to find them. That's why even moderate inflation hurts more now. And it's why if food and gas prices lift inflation even slightly above current rates, consumer spending could weaken and slow the economy. ..... < snip >
From Inflation Actually Near 10% Using Older Measure | Inflation Using Volcker-Era Methodology Nearing 10% - CNBC, by John Malloy, 2011 April 12
Since 1980, the Bureau of Labor Statistics has changed the way it calculates the CPI in order to account for the substitution of products, improvements in quality (i.e. iPad 2 costing the same as original iPad) and other things. Backing out more methods implemented in 1990 by the BLS still puts inflation at a 5.5 percent rate and getting worse, according to the calculations by the newsletter's web site, Shadowstats.com. "Near-term circumstances generally have continued to deteriorate," said John Williams, creator of the site, in a new note out Tuesday. "Though not yet commonly recognized, there is both an intensifying double-dip recession and a rapidly escalating inflation problem. Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead." The pay-site and newsletter by Williams, an economic consultant for the last 30 years to companies, has gained a cult following among bloggers hungry to criticize Bernanke these days. ..... < snip > ..... To be sure, the BLS argues that the changes it has made over the last three decades more accurately reflect a true change in the cost of living. For example, in response to its hedonic adjustments, the BLS web site states, "to measure price change accurately, the CPI must be able to distinguish the portion of price change due to this quality change." ..... < snip >
< snip > ..... Inflation, using the reporting methodologies in place before 1980, hit an annual rate of 9.6 percent in February, according to the Shadow Government Statistics newsletter.
Since 1980, the Bureau of Labor Statistics has changed the way it calculates the CPI in order to account for the substitution of products, improvements in quality (i.e. iPad 2 costing the same as original iPad) and other things. Backing out more methods implemented in 1990 by the BLS still puts inflation at a 5.5 percent rate and getting worse, according to the calculations by the newsletter's web site, Shadowstats.com.
"Near-term circumstances generally have continued to deteriorate," said John Williams, creator of the site, in a new note out Tuesday. "Though not yet commonly recognized, there is both an intensifying double-dip recession and a rapidly escalating inflation problem. Until such time as financial-market expectations catch up with underlying reality, reporting generally will continue to show higher-than-expected inflation and weaker-than-expected economic results in the month and months ahead." The pay-site and newsletter by Williams, an economic consultant for the last 30 years to companies, has gained a cult following among bloggers hungry to criticize Bernanke these days. ..... < snip >
..... To be sure, the BLS argues that the changes it has made over the last three decades more accurately reflect a true change in the cost of living. For example, in response to its hedonic adjustments, the BLS web site states, "to measure price change accurately, the CPI must be able to distinguish the portion of price change due to this quality change." ..... < snip >
A follow up:
Here is a graph of housing priced in oz of gold, going up to 2009, as you know gold has gone up significantly since then, so housing priced in gold is now at a historic low.
Heres another approach to explaining why hedonics / quality adjustments and substitution / chained dollars put into using geometric weighting have corrupted the CPI.
According to the BLS, the CPI is the most commonly used indicator of inflation, i.e. the average change over time in the cost of goods and services.
As such it influences interest rates, the stock market, and a host of salary and pension negotiations each year. It is used by the Federal Reserve to justify its money printing policies, to set the interest rate on inflation-adjusted bonds known as TIPS, and by the federal government to calculate cost-of-living adjustments (COLA) for the entitlement programs (e.g., Social Security). The more inflation is understated, the higher the inflation-adjusted rate of GDP growth that gets reported. In addition, the CPI influences interest rates, the stock market, and a host of salary and pension negotiations each year
All these uses require an index that measures the consumer cost of a set standard of living, i.e. an apples to apples comparison.
Concepts such as hedonics, quality adjustment, substitution effect, chained dollars, and intervention analysis are all soft metrics that introduce changes to actual consumers cost of purchasing a fixed basket of goods. The specious changes that reflect subjective value judgments from a government agency staffed with people who have more education than common sense and real life experience. When the CPI is calculated, these value judgments determine what quality changes are worth to you, when you will substitute one item for another, which items you will substitute for one another, and when a price goes up too much.
How for instance is the mandated replacement of incandescent light bulbs with CFLs valued? Which does life experience tell you happens: a positive quality change is determined because of the PC impact on climate change and the CPI is adjusted downward, or a negative quality adjustment is determined because of mercury added to land fills, increased electric usage for those places where lights are routinely only turned on briefly, increased headaches and even seizures in those who are sensitive to the flicker inherent in CFLs and the CPI is adjusted upward?
How do the mandated low flow toilets affect the CPI? Is the CPI adjusted downward because each flush uses less water and helps save the environment? Is the CPI adjusted upward because it often requires more than one flush to get the job done, or because when added to older plumbing the new toilet is prone to problems overflowing?
How about the substitution of PE for PPA, an OTC decongestant the FDA removed from the market for political not scientific reasons? Is the CPI adjusted downward because PE is politically correct and therefore represents a quality improvement or is it adjusted upward because PE is an inferior medication when compared to PPA?
Whether a quality change is positive, negative, or neutral is up to the individual consumer. When and what substitutions occur as a result of price change again is up to the consumer, based upon a host variable unique to each person.
What did you think of Cutepuppy’s post at #31?
You and Cutepuppy look at the same information with a reasonable understanding and come to differing conclusions. I can live with that. I understand the difference in perspective.
Now a slightly different question: Considering that a housing price bottom is still nowhere in sight, doesn’t that mean that actual Wealth (Net Worth, excluding recent stock gains) is still decreasing rapidly? Isn’t a continuous reduction in Wealth the equivalent of negative earnings, offsetting stagnant actual wages? Therefore, with relatively modest actual inflation (whether Headline or Core) and declining earnings (by my definition above), don’t we have an effective inflation rate of Prices / Earnings that is substantially higher than either Core or Headline CPI report?
I think the negative wealth effect of housing is killing families’ ability and willingness to spend their fewer and fewer asset / earnings dollars on the somewhat more expensive stuff of life.
That would perfectly explain the difference between CPI (modest increases) and Americans’ perceptions (we’re getting poorer and hosed.)
I think the bottomless housing market price indicts the “Owners Equivalent Rent” component of the CPI as optimistic. If Owners Equivalent Rent takes into account CURRENT market prices of houses which have declined, but the average American lives in a house and pays a mortgage based on a higher acquiring price of 5 years ago, then Owners Equivalent Rent understates what actually happens to peoples’ bank accounts. Mortgage payments that are hard to walk away from remain high, while the Owners Equivalent Rent component of the CPI declines. That’s just fakery.
The adjustable component of Owners Equivalent Rent only comes to particular individuals who default on their mortgages and walk away. In that way, only the morally suspect are rewarded with the actual reduction in Owners Equivalent Rent. Upstanding citizens who honor their commitments are killed by stagnant wages, reduced house asset value, and actual CPI. I don’t see how those folks aren’t completely hosed by current circumstance, in a way that effectively creates a massive CPI for them individually.
Your thoughts, gentlemen / ladies?
While you and I may not have fallen for all the ‘financial experts’ who used to taut ‘debt is good’, ‘your home will keep increasing in value’, ‘your salary will keep going up’, I have been surprised at how many people believed this. For these people ready access to cheap credit help hide the real impact of inflation on their lives.
Article also explains why different income groups will see and feel and, therefore, react to their personal or visible (price of food in grocery store, gas prices posted in large numbers at gas stations along the route) price inflation, and why there were suggestions of breaking index down into several different CPI rates, according to "baskets" by income, instead of BLS issuing the single "average" CPI.
That's also the conclusion from the article I linked before:
These days, inflation is much lower. Yet to many Americans, it feels worse now. And for a good reason: Their income has been even flatter than inflation.
Back in the '80's, the money people made typically more than made up for high inflation. In 1981, banks would pay nearly 16 percent on a six-month CD. And workers typically got pay raises to match their higher living costs. No more.
Much more relevant adjustment that has been made in the 1990s but doesn't get talked much about (maybe because it seriously overstated previous CPI) was change from arithmetic / compounded rates to geometric rates. (See Inflation, Hedonics, and How Silicon Valley May Have Wrecked Our Monetary Policy - Adam Nash, 2008 February 27)
The Bloomberg's Chart #3 that shows the difference between Core CPI and non-Core CPI is interesting in a couple of respects:
1. What sense would it make for BLS to understate Core CPI while at the same time showing "normal" non-Core CPI (which includes food and energy) - wouldn't they think that the difference would explode exponentially over time and lose their relative correlation over long period of time?
2. (Partially, an answer to 1.) The Bloomberg chart is only from the small period of early 2005 (during sharp housing and energy inflation) to the early 2008, just before the period of sharp housing and energy deflation. At that period, it's quite possible that non-Core CPI would dive faster and harder than Core CPI.
Here is a Bloomberg's chart for a Euro-Zone price inflation over period from 2005 to March of 2011, where you can see the "Big Swoon" from 2008 to 2010 (chart is "normalized" for annual rates, so it's easier to see):
Re OER (Owner Equivalent Rent):
It pays to take note that housing comprises about 30% of CPI, and that the disparity between the price of "similar" house is huge and varies greatly depending on state, city and other geography - "Location, Location and Location". Good luck measuring "average" house price, and the "equivalent" cost to the people who do not own one. It seems reasonable to "normalize" owners and renters with a common metric for the purposes of "average" index. OER is basically a first derivative of house ownership.
And while the housing prices were bubbling up dramatically in some geosectors of the country, the rents didn't (sometimes due to rent controls, sometimes due to market forces). That means that the usual metrics of the house pricing (Price to numbers of years of gross/net annual rent income, or PS/PE equivalent for equities) were getting seriously out of whack, i.e. people were paying more and more for the houses with the essentially same rent / OER.
Following articles explain the relationship between prices and rent or PS/PE, in different locales:
Housing Trends | America's Most Overpriced Real Estate Markets - Forbes, by Matt Woolsey, 2007 May 04
Housing Trends | Most Affordable U.S. Real Estate Markets - Forbes, by Matt Woolsey, 2007 August 02
Housing Trends | Least Affordable U.S. Real Estate Markets - Forbes, by Matt Woolsey, 2007 August 23
While BLS calculates the housing and OER in terms of "cost," the owners of property usually consider it "wealth." Of course, the ownership "wealth effect" obscured that fact, and the "flippers" didn't care about PS/PE ratios in the first place, during the bubble. Now the "wealth effect" is negative, but the rents generally are not coming down in price nearly as fast as the price of the house, so OER can smooth the inflation/deflation line (similarly to Core CPI) relative to more volatile (at least in recent years) real estate prices.
Basically, for the owners, the "wealth effect" obscured the relationship to rent prices (and their "natural" relationship to the price of the house) just as now the negative "wealth effect" obscures the fact that the rent prices have changed mostly with the "rate of inflation," or relatively little over last 5-8 years, while the ratios of property prices to rent had wide swings.
It makes sense that the people who think that CPI is understating the visible food and energy price inflation, would think that BLS also understates the decline in housing prices in some geographical areas that are visible signs of burst bubble (e.g., AZ, CA, FL, NV, NY) BLS is trying to measure the change in cost of "rent equivalent" or rent, not the change in wealth.
What we feel as overall price / cost increases or decreases is very subjective depending on our "reality" and our own "basket" of goods and services, and its relationship to our income and spending habits (our "weighting") - it very seldom resembles the "average" (which in itself is difficult enough to measure).
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