[Winstonm]

Over a period of time, many adjustment methods have been incorporated into the inflation statistics released in the U.S. The claim is to get a better and more realistic picture of inflation; however, I am from the Nixon era and as such have a healthy amount of skepticism for claims such as "Peace is at hand", "Your President is not a crook," and "We have improved your benefits."

The potential problem I see is in "hedonic" pricing methods. Using this as a guage, my understanding is "value" is included in pricing, i.e., a car built today that sells for $30,000 is more sophisticated and has more intrinsic value than a car built 20 years ago and sold for $10,000 - in fact, the price of the automobile has declined - or at least has had the benefit of deflation. Another that comes to mind is equivalent rents - ignoring ownership costs of housing by substituting the rental price of an equivalent house. Combining these, you can actually get economist showing a decline in rents based on receiving things like air conditioning, built in microwaves and the like when in fact prices are rising.

Another strange concept is "chained" indexes. With this, a basket of goods is priced. The theory supposedly being if the price goes up on one item in the basket the consumer will replace that item with a lower cost one. So if you have cherries in the basket, and the price of cherries goes up, the consumer will switch to cheaper grapes and thus the basket price remains the same - no inflation.

The last that comes to mind is Core Inflation Rate, or CPI. With this little diddy, you toss out food and energy costs because of their volatility. So if the price of gas in the U.S. goes from $3 a gallon to $6 a gallon and the price of food surges by another 100% we still have no inflation - forget the fact that we eat food daily and use energy daily - but clothes haven't risen yet! And if they do, we can replace the Calvin Kleins in the basket with Goodwill hand-me-downs anyway.

All of this slight-of-money trickery would be nothing more than a parlor game about how the rich get richer and would be much ado about nothing except for one glaring problem....

Fixed incomes.

With fixed incomes tied to the inflation rate, wouldn't it behoove us to determine true inflation rates?

I have read that the current U.S. core rate of 2.4% annualized would be more like 4.5-5% if we used the same measures we did when Carter was president.

Are these measures truly incorporated to improve statistical reliability or are they nothing more than razzle-dazzle to make GDP look better than it is while inflation is shown lower than it truly is - and for what reason would this be done? Foreign investement. It is imperative the U.S. continue to show a solid economy with managable inflation else the world pulls its dollars and there goes the entire charade.

What is your opinion?

[inquiry]

Dont need no stinking indexes to tell me that this year everything cost more than last year.... and the incredible shrinking size of products. A lb of bacon is now 12 oz, Mayonnaise that was 32 oz last year is 28 oz this year. Gas? Doubled in price since last summer. HEck, even need a credit card to buy fast food now days as it cost so much (what happened to the 99 cent meals). A house that cost 200,000 a few years ago sells for 480,000 today. What do you call this? Don't need an index for this.

[helene_t]

Some newspapers used to publish the MacDonals price index because they didn't trust the official price index.

But I think that including the value of a commodity in the pricing is in principle a good thing. The alternative would be to exclude electronic consumer goods from the price index alltogether. Depends what the purpose of the price index is.

This "basket" principle sounds weired. Of course the basket has to be recomposed as consumtion patters change from spending less money on horse stabling and more on iPods, but this is a long term thing and todays prices should be compared to those of 2005 based on the same basket.

[Echognome]

Mind you that I am a micro economist working on regulation and antitrust and therefore most of my macro knowledge is from my undergraduate degree and a few courses in grad school. But...

Quote

The potential problem I see is in "hedonic" pricing methods.  Using this as a guage, my understanding is "value" is included in pricing, i.e., a car built today that sells for $30,000 is more sophisticated and has more intrinsic value than a car built 20 years ago and sold for $10,000 - in fact, the price of the automobile has declined - or at least has had the benefit of deflation. 

Hedonic pricing simply means that we value a good not as a whole unit, but rather as the sum of its parts. Imagine we are comparing two computers. Do we say that the one with the 3.4 GHz processor, 100 Gb hardrive, 17" screen, and DVD burner is better? Or the one with 6.4 GHz processor, 200 Gb hardrive, 13" screen and no DVD drive is better? Now imagine we have a whole bunch of computers we want to compare. Hedonic pricing means we attach a 'value' to each component that makes up the computer and then compare that based on the sum of the values. Note that we do not make each customer have the same value over each component. One of the seminal papers in this area was on automobile purchases and matching up characteristics of the household with the cars they purchased. (e.g. minivans were bought more often by those with 3+ kids, sports cars bought by rich people, pickup trucks by those in rural areas, etc.) So that may help you understand the jargon "hedonic pricing".

Quote

Another that comes to mind is equivalent rents - ignoring ownership costs of housing by substituting the rental price of an equivalent house.  Combining these, you can actually get economist showing a decline in rents based on receiving things like air conditioning, built in microwaves and the like when in fact prices are rising.

I don't know a whole lot about this. I imagine that the government has to compare the "price" of housing between those that own and those that rent.

Quote

Another strange concept is "chained" indexes.  With this, a basket of goods is priced.  The theory supposedly being if the price goes up on one item in the basket the consumer will replace that item with a lower cost one.  So if you have cherries in the basket, and the price of cherries goes up, the consumer will switch to cheaper grapes and thus the basket price remains the same - no inflation.

Chained indexes basically mean we are adjusting for inflation in comparison. If you earned $10000 a year in 1974 and $40000 a year in 1994 are you richer in 1974 or in 1994? Well you have to adjust for inflation in order to compare. So usually you just pick a base year (let's say 1960 dollars as an example). Then you can compute that $10000 in 1974 is worth, say $5000 in 1960 dollars and $40000 in 1994 is worth say $5500 in 1960 dollars. So you thus have a relevant comparison. The "chain" aspect is the adjustment year to year. 1975 compared to 1974 is 1.034. 1976 compared to 1975 is 1.01. etc.

The second part of this paragraph is just misunderstanding a basic concept. Suppose that we doubled all prices in the economy, but we also doubled everyone's incomes. Then prices haven't really changed. We can still buy the same amount of goods we were buying before and after all, we don't value money, but rather the goods that money buys us.

Quote

The last that comes to mind is Core Inflation Rate, or CPI.  With this little diddy, you toss out food and energy costs because of their volatility.  So if the price of gas in the U.S. goes from $3 a gallon to $6 a gallon and the price of food surges by another 100% we still have no inflation - forget the fact that we eat food daily and use energy daily - but clothes haven't risen yet!  And if they do, we can replace the Calvin Kleins in the basket with Goodwill hand-me-downs anyway.

I am not sure that Core Inflation Rate is defined to be the same thing as the Consumer Price Index (CPI). There is also the Producers Price Index (PPI). The latter two are the most common measures of inflation. In order to calculate these they have to take a bundle of goods (typical expenditures by a household) and follow how the prices go up or down overall. Since it is impossible for the government to track ALL prices of EVERY good, they have to take a sample. I am not aware of what they include in these bundles of goods, but I am sure that they consider a lot more than you would imagine.

Quote

All of this slight-of-money trickery would be nothing more than a parlor game about how the rich get richer and would be much ado about nothing except for one glaring problem....

Fixed incomes. 

With fixed incomes tied to the inflation rate, wouldn't it behoove us to determine true inflation rates?

I have read that the current U.S. core rate of 2.4% annualized would be more like 4.5-5% if we used the same measures we did when Carter was president.

Are these measures truly incorporated to improve statistical reliability or are they nothing more than razzle-dazzle to make GDP look better than it is while inflation is shown lower than it truly is - and for what reason would this be done?  Foreign investement.  It is imperative the U.S. continue to show a solid economy with managable inflation else the world pulls its dollars and there goes the entire charade.

Fixed incomes often have a Cost Of Living Adjustment (COLA) as do many union wage contracts. The idea is simply that since prices rise, so should incomes to keep households as well off as they were before. I cannot argue whether today they measure inflation "better" or "worse" than they did when Carter was president. I imagine they use a lot more information today than they did then. So the fact that using an older measure overestimates inflation doesn't surprise me. If you want to argue whether the measures are better or worse, then you need to look up the definitions of how they measure it today versus how they measured it then. I'm afraid this area of economics does not really excite me, so I don't keep track of how all of these measures are done.

I also don't believe the consequences of high inflation are that foreign direct investment falls. I don't see why inflation would make GDP change. So how are you making these great causal linkages?

[helene_t]

Echognome, on Aug 8 2006, 11:30 AM, said:

I don't see why inflation would make GDP change.

Growth in GDP is usually corrected for inflation, so it matters how much inflation to subtract from the GDP.

[Echognome]

helene_t, on Aug 8 2006, 12:00 PM, said:

Echognome, on Aug 8 2006, 11:30 AM, said:

I don't see why inflation would make GDP change.

Growth in GDP is usually corrected for inflation, so it matters how much inflation to subtract from the GDP.

Right. I can see how change in GDP growth can be affected when presented in real dollars. But GDP itself is measured irrespective of inflation.

[Winstonm]

Echognome, on Aug 8 2006, 04:30 AM, said:

Mind you that I am a micro economist working on regulation and antitrust and therefore most of my macro knowledge is from my undergraduate degree and a few courses in grad school.  But...

Quote

The potential problem I see is in "hedonic" pricing methods.  Using this as a guage, my understanding is "value" is included in pricing, i.e., a car built today that sells for $30,000 is more sophisticated and has more intrinsic value than a car built 20 years ago and sold for $10,000 - in fact, the price of the automobile has declined - or at least has had the benefit of deflation. 

Hedonic pricing simply means that we value a good not as a whole unit, but rather as the sum of its parts. Imagine we are comparing two computers. Do we say that the one with the 3.4 GHz processor, 100 Gb hardrive, 17" screen, and DVD burner is better? Or the one with 6.4 GHz processor, 200 Gb hardrive, 13" screen and no DVD drive is better? Now imagine we have a whole bunch of computers we want to compare. Hedonic pricing means we attach a 'value' to each component that makes up the computer and then compare that based on the sum of the values. Note that we do not make each customer have the same value over each component. One of the seminal papers in this area was on automobile purchases and matching up characteristics of the household with the cars they purchased. (e.g. minivans were bought more often by those with 3+ kids, sports cars bought by rich people, pickup trucks by those in rural areas, etc.) So that may help you understand the jargon "hedonic pricing".

Quote

Another that comes to mind is equivalent rents - ignoring ownership costs of housing by substituting the rental price of an equivalent house.  Combining these, you can actually get economist showing a decline in rents based on receiving things like air conditioning, built in microwaves and the like when in fact prices are rising.

I don't know a whole lot about this. I imagine that the government has to compare the "price" of housing between those that own and those that rent.

Quote

Another strange concept is "chained" indexes.  With this, a basket of goods is priced.  The theory supposedly being if the price goes up on one item in the basket the consumer will replace that item with a lower cost one.  So if you have cherries in the basket, and the price of cherries goes up, the consumer will switch to cheaper grapes and thus the basket price remains the same - no inflation.

Chained indexes basically mean we are adjusting for inflation in comparison. If you earned $10000 a year in 1974 and $40000 a year in 1994 are you richer in 1974 or in 1994? Well you have to adjust for inflation in order to compare. So usually you just pick a base year (let's say 1960 dollars as an example). Then you can compute that $10000 in 1974 is worth, say $5000 in 1960 dollars and $40000 in 1994 is worth say $5500 in 1960 dollars. So you thus have a relevant comparison. The "chain" aspect is the adjustment year to year. 1975 compared to 1974 is 1.034. 1976 compared to 1975 is 1.01. etc.

The second part of this paragraph is just misunderstanding a basic concept. Suppose that we doubled all prices in the economy, but we also doubled everyone's incomes. Then prices haven't really changed. We can still buy the same amount of goods we were buying before and after all, we don't value money, but rather the goods that money buys us.

Quote

The last that comes to mind is Core Inflation Rate, or CPI.  With this little diddy, you toss out food and energy costs because of their volatility.  So if the price of gas in the U.S. goes from $3 a gallon to $6 a gallon and the price of food surges by another 100% we still have no inflation - forget the fact that we eat food daily and use energy daily - but clothes haven't risen yet!  And if they do, we can replace the Calvin Kleins in the basket with Goodwill hand-me-downs anyway.

I am not sure that Core Inflation Rate is defined to be the same thing as the Consumer Price Index (CPI). There is also the Producers Price Index (PPI). The latter two are the most common measures of inflation. In order to calculate these they have to take a bundle of goods (typical expenditures by a household) and follow how the prices go up or down overall. Since it is impossible for the government to track ALL prices of EVERY good, they have to take a sample. I am not aware of what they include in these bundles of goods, but I am sure that they consider a lot more than you would imagine.

Quote

All of this slight-of-money trickery would be nothing more than a parlor game about how the rich get richer and would be much ado about nothing except for one glaring problem....

Fixed incomes. 

With fixed incomes tied to the inflation rate, wouldn't it behoove us to determine true inflation rates?

I have read that the current U.S. core rate of 2.4% annualized would be more like 4.5-5% if we used the same measures we did when Carter was president.

Are these measures truly incorporated to improve statistical reliability or are they nothing more than razzle-dazzle to make GDP look better than it is while inflation is shown lower than it truly is - and for what reason would this be done?  Foreign investement.  It is imperative the U.S. continue to show a solid economy with managable inflation else the world pulls its dollars and there goes the entire charade.

Fixed incomes often have a Cost Of Living Adjustment (COLA) as do many union wage contracts. The idea is simply that since prices rise, so should incomes to keep households as well off as they were before. I cannot argue whether today they measure inflation "better" or "worse" than they did when Carter was president. I imagine they use a lot more information today than they did then. So the fact that using an older measure overestimates inflation doesn't surprise me. If you want to argue whether the measures are better or worse, then you need to look up the definitions of how they measure it today versus how they measured it then. I'm afraid this area of economics does not really excite me, so I don't keep track of how all of these measures are done.

I also don't believe the consequences of high inflation are that foreign direct investment falls. I don't see why inflation would make GDP change. So how are you making these great causal linkages?

Thanks for the lengthy and well explained answers. By reading it should be easy to see I am no economist.

However, there are certain practices I have read about that make me wonder.
As others have pointed out, GDP adjusted for inflation depends quite a lot on the inflation number - I have seen some quotes that this number is as much as 1% inflated due to the undervaluation of inflation.

I understand what you are saying about the differences in the quatlity inherent in some products - a better computer for example. There are still a lot of debate in this theme but in my admittedly limited experience I have seen innovation cost more in the near term and reduce in price as technology improved. Satellite t.v. comes to mind. The first big dishes were around 3000 dollars or so - now you can get a small dish for about 100 dollars - acknowleged that they are not exactly the same thing - but then neither are the cars of today the same as the older cars.

The article I read that spurred my interest talked about apartment rents, that value addition for things like air conditioning and location above the first floor, etc., could actually show a reducing inflation when the rent per square foot was rising.

So I question, knowing that this may be a logical and reasonable attempt to better judge true inflation; but I also am aware that there could be other reasons less pure and wonder if this were an attempt to be disinginuous, what would be the reward? I speculated foreign investment, as a bunch of nervous foreign money worried about the U.S. economy's health could play havoc with the U.S. debt load and the dollar.

So the question is: if this were an attempt to camoflage the truth, what would be some of the goals and aims of doing so?

[Winstonm]

Quote

"If you're on the receiving end of a consumer price index, you're being cheated," says John Williams, founder of economic newsletter ShadowStats.com and an economic consultant. Williams is mistrustful of the government's measures of inflation, and he's not alone, since the federal government has incentives for CPI to be lower. The statistic is tied to cost-of-living increases made to Social Security beneficiaries, to commercial leases and union labor contracts among other types of contracts. "

So as you see, the question is not really about economics at all - the question is "can U.S. citizens trust their government?"