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Why inflation is lower than you think
By Advisor Perspectives
Financial pundits routinely claim that inflation is much higher than the reported statistics. We hear, for example, that food prices have risen much faster than the roughly 1.5% increase in the consumer price index (CPI) over the past several years. Viewed over the longer term, however, inflation is far lower than reflected in the published data.
The reason for this anomaly is that the CPI doesn’t reflect the rapid advances in technology and the new products and services that have benefited everyone.
The implications are profound. For example, real GDP growth is greater than has been reported, and some claims of income inequality are misleading.
This theme was the focus of two recent presentations I attended. On October 18, the economist Woody Brock hosted a private gathering of investment professionals from Australia and New Zealand, organized by the Portfolio Construction Forum, at his home in Gloucester, Massachusetts. On October 22, Rick Rieder, the CIO of fundamental fixed income at BlackRock, spoke at the CFA Institute Fixed-Income Conference in Boston.
Let’s look at the distortions in the reported inflation statistics and the implications they have for policymakers.
The problems with the CPI and PCE
The CPI, which is administered by the Bureau of Labor and Statistics (BLS), and the personal consumption expenditure (PCE) index, which is the Fed’s preferred metric for measuring inflation, rely on tracking the prices of a basket of consumer goods. Those goods include food, clothing, energy and housing, which is the largest component of both indices.
They differ in that the PCE maintains fixed weightings, whereas weightings in the CPI are adjusted over time. The CPI also incorporates “hedonic” adjustments; it assumes, for example, that if the price of beef increases rapidly, then consumers will adjust their tastes and purchase more chicken. As a result of the difference in weightings, over time the CPI reports lower inflation than the PCE.
But the problem is that the hedonic adjustments do not fully reflect advances in technology.
As Brock said, the published inflation data “seriously overstates inflation.”
Technology advances are apparent in the quality of televisions, which has improved vastly over the past 50 years; compare the small black-and-white TV sets of the 1960s to today’s 60-inch high-definition flat-screen pictures. As Brock noted, the typical lifespan of light bulbs has increased from four months to nearly 20 years over the last couple of decades. Our chances of surviving a motor vehicle accident is five-times greater since the introduction of seatbelts and airbags.
Read more at Advisor Perspectives.
Photo: Lucas Stanley