Seeing Inflation Only in the Prices That Go Up
Seeing Inflation Only in the Prices That Go Up
By DAVID LEONHARDT
Published: May 7, 2008
Next week, the Bureau of Labor Statistics will release its monthly report on inflation, and it sure is going to sound strange. Wall Street is expecting the bureau to announce that the Consumer Price Index rose just three-tenths of a percentage point in April. Over the last year, the index has risen only about 4 percent.
Pumps show gasoline prices in Newbury, N.H., in the 1960s. Federal Reserve officials base interest rates on underlying price trends, instead of being overly influenced by gas or food prices.
I’m guessing that doesn’t square with your sense of reality.
In my household, we just broke the $60 barrier for filling up our gas tank. Nationwide, the price of bananas is up almost 20 percent over the last year, while eggs are up 35 percent. Costco and Sam’s Club recently began rationing rice, to prevent hoarding. All the while, some of the big-ticket items that have been getting more expensive for years — like health care and college — just keep on getting more so.
This contrast between the official government statistics and day-to-day reality has led to a boomlet in skepticism about what the government is up to. Last month, when I did an online Q. and A. with Times readers, I got three separate, thoughtful questions about — of all things — how the inflation rate is calculated. The current cover story in Harper’s, called “Numbers Racket: Why the Economy Is Worse Than We Know,” deals with the same subject. Written by Kevin Phillips, the Nixon aide turned left-leaning commentator, it concludes that the real inflation rate “is as high as 7 or even 10 percent.”
This isn’t just an academic discussion about numbers, either. The Consumer Price Index helps determine the size of Social Security checks and affects annual raises at many companies. If the index is wrong, senior citizens and workers are being cheated, and the economy is indeed much worse than we know.
So what’s going on here?
To answer that question, it helps to go back a few years, to a time when trips to the supermarket didn’t induce sticker shock. In 2003, a pound of hamburger cost all of $2.20. More than two decades earlier, in 1980, it cost $1.86, which means that the nominal price of burger meat rose only 18 percent over a period in which the nominal hourly pay of the typical American worker rose 150 percent.
Similar stories can be told about eggs, bananas, bread and frozen orange juice. Food was getting cheaper relative to everything else, as Neil Harl, an agriculture professor at Iowa State University, explained to me, because of a combination of government subsidies, global trade and the rise of industrial farms.
During the 1980s and 1990s, though, did you ever stop and marvel at what a small share of your paycheck you were spending at the supermarket? I didn’t. I also didn’t really notice that gas cost less in the late 1990s than it had in the 1980s. Yet lately, every time my wife or I pass a new benchmark for filling up our tank — $40, $50 and now $60 — we have a conversation about it.
Price increases are simply more noticeable — more salient, as psychologists would say — than price decreases. Part of this comes from the notion of loss aversion: human beings dislike a loss more than they like a gain of equivalent size. If you have to sell your house for less than you bought it for, you’re really unhappy. You hate that ground chuck now costs $2.83 a pound, but you didn’t notice that oranges are 31 percent cheaper than they were a year ago.
There is also something particular to inflation that aggravates loss aversion. Price increases are obvious. But price declines are often hidden. The cost of an item stays about the same for years, while everything else gets more expensive and nominal incomes rise.
When you dig into the Consumer Price Index, you start to realize just how many things fall into this category. The price of major appliances has been flat over the last year. Furniture is 1 percent less expensive. A decade ago, a basic four-door Toyota Corolla LE cost $16,018, according to the company. The 2009 basic model costs $16,650, and it’s a safer, more powerful, more fuel-efficient car than its predecessor.
To top it all off, most people don’t buy any of these items very often. “People tend to remember things they do frequently,” says Stephen Cecchetti, an economist at Brandeis University who studies inflation. “And what do you buy more frequently than gas and food?”
But combine the less noticeable trends with some true price declines, like a 5 percent drop in women’s clothing over the last year, and an inflation rate of 4 percent starts to seem more reasonable. Inflation really has gotten worse recently — it was only 2 percent a year and a half ago — but it’s not as bad as it feels.
The conspiracy theories about inflation play off these human instincts, but they also depend on two other oddities. The first is the amount of attention given to the so-called core inflation rate. This is a version of inflation that excludes food and energy, which makes it a little like a grade point average that excludes math and French.
The core inflation rate does have a purpose. Its movements help Federal Reserve officials base interest rates on underlying price trends, instead of being overly influenced by food or gas prices, both of which can be volatile. But when Ben S. Bernanke, the Fed chairman, talks publicly about core inflation, he can leave the impression that the government is cooking the books. In fact, all the important economic indicators, including real wages, are based on overall inflation, as are Social Security checks and cost-of-living raises.
The final piece of the puzzle — and the focus of the Harper’s article — is the way that the Bureau of Labor Statistics has changed the price index recently. Back in the mid-1990s, a committee of academic economists concluded that the Consumer Price Index overstated inflation. To take just one example, years would often pass before the index included new products — like cellphones — and therefore it missed the enormous price declines that occurred shortly after those products entered the mainstream.
In response, the bureau tweaked the index. But economists who have studied the changes say they have had only a modest effect on the inflation rate, lowering it by perhaps a half point a year. More to the point, the changes seem to have made the index more accurate than it used to be.
“It’s about as accurate as anybody is going to get it,” Mr. Cecchetti said.
That said, there is one way in which the official numbers were clearly understating inflation. To track housing costs, the Consumer Price Index analyzes rents, not home prices. (Why? Long story.) And rents didn’t go up anywhere near as much as house prices during the real estate boom. So the index missed the huge run-up in home values that made life harder on anyone trying to buy a first home.
Since 2006, of course, home prices have been falling. But rents have kept rising slowly, which means that, as far as the Consumer Price Index is concerned, housing has somehow gotten more expensive during the real estate crash.
So when the new inflation numbers come out next week, they will indeed be misleading. They will be artificially high.
http://www.nytimes.com/2008/05/07/business/07leonhardt.html
