Keep Inflation Unchained

Inflation

President Obama’s latest budget indexes cost-of-living-adjusted benefits like social security against chained-CPI, rather than the regular CPI that has been used case previously.

This is undoubtedly a cost-cutting measureaccording to the numbers used, the measure “will reduce deficits by at least $230 billion over the next 10 years”.

But is Obama using the right numbers? Chained CPI is by definition not an apples-to-apples index. It tries to correct for what is called substitution bias, the idea that if prices are rising in apples, the basket of goods used to calculate inflation should be adjusted to include more of a substitute rising less fast. A truer measure of inflation would count the increase in the price of apples based on how many apples people were eating prior to the price increase, not just assume away the increase based on the assumption that people will switch to oranges. I like oranges. But if the price of apples is soaring, inflation figures should reflect this.

So chained CPI is a fudge, and a slippery slope. Taken to its logical conclusion  if the price of steak is soaring, but the price of pink slime (or, to give it its euphemistic name “lean finely-textured beef”) remains cheap then consumers may be assumed to substitute pink slime for steaks. That isn’t measuring the cost of living. That’s just an austerity fantasy.

Trying to appease the Washington Post editorial board is no substitute for sound economic principles. When we measure inflation, we should use the best data available. As far as I can tell, that’s MIT Billion Prices Project which indexes by far the largest range of prices. More data means more accuracy.

According to their methodology, the CPI is very slightly underestimating the level of inflation, not overestimating it:

BPP

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6 thoughts on “Keep Inflation Unchained

  1. Substitution bias. That is why the worlds fashion standard is a T shirt.

    Well tailored shirts are too expensive. Why?

  2. Whatever the CPI number they come up with, household budgets are the same. When all the essentials prices are going up such as food, education, energy, rent, medical etc., one has less money to spend on all other can-live-without items such computer, cellphones (I know somebody just got rid of her cellphone recently) entertainment, eating out, clothes etc. So no matter how they massage the CPI number, companies that are not making essential stuffs will do poorly and unemployment will remain high.

    When rent increases, the land lords are taking away the money from other industries. When medical and education expenses are high, they take away money from other industries.

  3. I have shopping dockets stored. I will test this substitution bias by swapping the products for similar ones that are cheaper.

    My question is this. In Australia (And I assume worldwide) Big Supermarkets are devoting bigger and bigger shelf space to plain labelled “House or Homebrand” Products. These are the cheapest already.

    Should the Government use these products as a benchmark?
    How do statisticians account for loss leading in essentials like eggs, milk, bread etc, which bring shoppers into the store, but distort price signals in the market.

    In Australia milk has been kept artifically low buy extreme price negotiations, now dairy farmers are walking away. Once the walk away will we see proper inflation due to lack of supply and excess demand?

    Is Soy Milk a substitution for real milk, because it makes the coffee whiter? Is it a whitener, vegetable juice or dairy food?

    Hedonics sounds like something dreamed up in Soviet times. Let them eat soy!

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