Those exorbitant inflation figures? They can be underestimated

Consumer prices are rising at the fastest rate in about 40 years, climbing 8.3% in April from a year earlier.

As popular anger over rising costs mounts, a chorus of critics have argued that the sky-high inflation figure is actually an understatement.

In YouTube videos, conservative talk shows and articles by financial analysts, critics claim that over the past few decades economists have changed one of the government’s standard measures of inflation, the index of consumer prices, so as to underestimate how quickly prices are rising. . These lower inflation figures give the government economic leeway, they argue, saving money on expenses like Social Security.

“At the end of the day, those aren’t exact numbers,” Fox News host Tucker Carlson said during a segment on inflation late last year. He added: “Do the math and you will see that the real number, the rise in inflation, is not even close to the 7% that Washington is claiming.”

But inflation experts say changes to the calculations over the years have made the reported rate a more accurate snapshot of price increases for buyers. The rate under a different methodology could be higher, they say, but the effect would be small and the alternative number would be less reflective of the costs consumers faced. Inflation affects different people differently, but that doesn’t mean the overall numbers are wrong.

“You have to understand the concept: what are people currently paying to consume? said Alan Detmeister, who was previously head of the prices and wages section at the Federal Reserve and is now at UBS Bank. “He’s trying to get expenses reimbursable.”

Here are two major changes to inflation since the 1980s and why economists embraced them.

Change 1: Inflation does not include real estate prices

People skeptical of inflation measures in the United States often cite a change in the way housing costs are measured in the Consumer Price Index, a closely watched measure produced by the Bureau of Labor Statistics.

In 1983, the government switched from using house prices – which also included mortgage payments and maintenance costs – to using rent prices to assess the cost of housing.

The cost of housing for people who own their property is now measured by what is called the “equivalent owner’s rent”: how much their house would cost to rent if they did not own it.

The idea is that houses are an investment. House prices are rising and you may be able to sell a property you have purchased for a profit. Rent, however, represents consumption. It doesn’t leave you with an asset that you can sell later.

Critics often argue that by leaving house prices out of the equation, the inflation measure underestimates the cost of living at times when house prices rise dramatically and it costs more to first-time buyers to gain a foothold in the market. Some even claim that if the government used the old methodology, its reported inflation rate would be much higher today than it was in the 1980s.

It’s true that inflation isn’t perfectly comparable over time due to the change in the way housing has been measured, said Omair Sharif, founder of research firm Inflation Insights. But the change would not be enough to make current inflation higher than the nearly 15% it reached 40 years ago.

“Yes, inflation today would be higher, but by about 1.25 percentage points, not the 4 to 5 percentage points that people say,” said Sharif, who last year mined data on house prices, mortgage costs, and home repairs from the 1970s, applied the relevant weights, and did the math on the old numbers to see how much the change in methodology changed inflation.

“It wasn’t a mind-blowing number like a lot of people think,” he said.

Another estimate – using calculations used in an article for The Quarterly Journal of Economics and updated for the Full Stack Economics newsletter – found that including house prices and interest rates instead of rent would have pushed the inflation rate at 11.5% in February, the latest date. available, up 3.6 percentage points from the official figure that month. This is more than Sharif’s estimate but still less than the 1980s.

Change #2: Economists trade expensive goods for cheaper goods

Economists once collected a basket of items — like eggs, milk, shampoo and other items — and simply tracked their cost over time, updating the basket only infrequently. But this measure has been criticized for potentially overestimating inflation because it ignored that consumers adjust their spending both over time and as prices rise.

Economists started updating the basket more regularly about 20 years ago, and the weights are now reset every two years to reflect what people are actually spending their money on.

They also tried to account for substitutions. Imagine that the price of cupcakes has gone up for a month. Instead of paying more, a consumer could buy cookies instead – a decent but cheaper dessert alternative – and their monthly costs would not increase.

They can also buy a container with fewer cupcakes, switch to a cheaper brand, or buy from a discount store where the cupcakes are cheaper. To account for this behavior, the government tweaked the way it calculates inflation in certain categories in 1999, correcting the problem in the eyes of many economists.

Critics sometimes raise another point: product swaps are made between entirely different categories, such as using chicken when the price of steak rises. These larger substitutions are not included in the normal CPI calculation, but are included in a measure called the chained consumer price index. While the CPI showed prices rose 8.3% in April from a year earlier, the chained CPI was a bit more subdued at just 7.8%.

Do you think these changes are not enough? There will certainly be others. The Ministry of Labor is still constantly making changes in an attempt to make the CPI a more accurate reflection of reality.

“It’s a good long-term method,” Detmeister said at UBS. “Over the course of a few months, or even over the course of a year, it may differ from what is happening on the ground.”