Inflation: Why might it be worse than the CPI data?

There was a nice post on “The Inflation Disconnect” at MacroBlog by the good folks at the Federal Reserve Bank of Atlanta last Friday.  (This was following up on an earlier post on “Inflation Confusion“.) They explained how the Federal Reserve attempts to keep an eye on inflation in many ways besides looking at the Consumer Price Index data.

As a comment there, I suggested the following three (really 4) possible “inflation disconnects”, three ways in which the Federal Reserve’s view of inflation might differ from grassroots realities, that were not covered in the MacroBlog article (though the first is alluded to in the comments there):

(1) Inflation in necessities hits the poor much harder than the rich. In recent decades, Per Capita GDP has been skewed to the high side by changes in income distribution. The median income has not done as well. The basket used in the computation of the various CPIs doesn’t do a very good job of representing the budget impacts of the current price changes on lower-income vs. upper-income folks.  When rent, gas, food and clothing are the bulk of your budget, it doesn’t really matter if the CPI stays low because computers and digital toys are getting cheaper and property prices are declining… you still have to choose between paying rent, getting to work, having servicable clothes and eating.

(2) Inflation as measured by the CPI has a very large fraction allocated to “owner’s equivalent rent”, which is very badly measured.  From 2004-2008 the OER totally missed the housing bubble, which was an inflationary disaster for anyone trying to buy a home with traditional financing.  More recently, declines in OER have offset some of the inflation in other areas, particularly food and fuel. But for those consumers who either own homes outright (no mortgage) or who bought a house in the bubble (with nontraditional financing), the decline in home values is a negative, not a positive.  The inclusion of OER in the CPI is grossly disconnected from the budgetary realities of these households.

(3) It might be worth questioning whether the REIN approach of surveying business leaders provides an unbiased view of price changes and inflationary trends. Business leaders profiting from low interest rates can hardly be expected to give answers which would lead the Federal Reserve to raise interest rates!  (Note that this doesn’t mean anyone is intentionally being misleading; there are plenty of examples where even very conscientious people will, without thinking about it, give misleading answers — if their incentives are misaligned.) Even if one doesn’t go that far, based on recent economic history it’s clear that a lot of business owners (especially in finance) have no clue what is actually going on in their business, and they may in fact be as ignorant as the Federal Reserve about price changes being implemented at much lower levels. In particular, there is a fair amount of evidence that businesses have been passing on higher costs by changing product size & volume without changing the “price” on the package. Do the leaders of those businesses actually report such changes via REIN?

(4) Bonus item:  One thing the REIN group does not provide is a representative sample of consumers. Additionally, you can learn how to outsource the payroll. Given the importance of accurate inflation data to policymaking, and given the resources available to the U.S. Government and Federal Reserve, why isn’t there a “household survey” of consumers regarding their budgets and inflation perceptions, to complement the CPI and the REIN “establishment survey”?  In other words, shouldn’t there be a reporting structure analogous to the monthly payrolls report, which is one of the actual reasons why we need paystubs. When considering outsourcing options, it’s essential to explore the services offered by a reliable BPO provider.

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