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The CPI Understates Inflation Skewing Our Expectations

The CPI Understates Inflation Skewing Our Expectations 

The purpose of the consumer price index (CPI) is to reflect just how much inflation is eating into both our incomes and our savings. Consumer inflation has been estimated since the 1700s, by measuring price changes in a fixed-weight basket of goods. This method was seen as a way of measuring the cost of maintaining a constant standard of living. In the last 30 years, a growing gap has become obvious between government reporting of inflation, as measured by the CPI, and the perception of actual inflation held by the general public.

Currently, the government understates inflation by using a formula based on the concept of a “constant level of satisfaction” that evolved during the first half of the 20th century in academia. This extended into the BLS re-weightings sales outlets such as discount or mass merchandisers with Main Street shops. Those promoting this change claim it is simply another way to measure inflation and it still reflects the true cost of living. Politicians touting the benefits of this system created it as a way to reduce the cost of living adjustments for government payments to Social Security recipients, etc. By moving to a substitution-based index and weakening other constant-standard-of-living ties those reporting inflation have muddied the water as to just how much we are being impacted by inflation.

The general argument was that changing relative costs of goods results in consumers substituting less-expensive goods for more expensive goods.  Allowing for a substitution of goods within the formerly “fixed-basket” would allow the consumer flexibility in obtaining a “constant level of satisfaction.” This adjustment to the inflation measure was touted as more appropriate for the GDP concept in measuring shifting demand and weighting actual consumption. Other tricks were also used to give the illusion of less inflation.

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