Sunday, October 16, 2005



That headline sure sounds ominous. September’s inflation rate was a shock, frequently described as the greatest increase in inflation since March of 1980. And depending on how you measure inflation, the dogs of inflation are:

1. Rampaging through the streets of major cities.
2. Only chewing up the carpet.
3. Just tugging on their leashes and howling a bit.

Measuring inflation is not as simple as it looks. If one follows the financial press, two measures are commonly referenced. The Consumer Price Index and the Wholesale Price Index. And subsets of these indices. If one reads the newspaper or watches the television network news, the Consumer Price Index is the usual topic. Let’s check out the Consumer Price Index, commonly abbreviated as the CPI.

The CPI is a “market basket of goods and services” measured monthly by the Bureau of Labor Statistics. Common categories of expenditures, such as food, housing, energy, healthcare, apparel, major appliances, airfares, and new car prices are given a percentage of the total market basket of goods. For example, housing is given about 23% of the basket and healthcare is given about 6%.

Each month changes in the costs of the goods and services in these market basket categories are measured and plugged into their respective percentage composition of the market basket. So if housing prices go up 1% in a month, then the 23% housing allocation in the CPI will go ups by 1%. This change, and categories are totaled and a monthly CPI increase is tallied. Sounds simple, right?[i]

One often hears about two measures of the CPI. The CPI, and the Core CPI, the CPI without the “volatile food and energy sectors”. These “volatile” sectors are excluded to maintain a longer term perspective in the CPI figures. So if we only look at core inflation for September 2005, the CPI was up by 0.1%, in line with the last few months of CPI increases. By this measure, the dogs of inflation are just tightening their chains a little

The CPI including energy and food is a little more ratcheting. All Americans are paying more for food and fuel. But for many Americans, the poor, and the working poor, increases in food and energy costs tear at the core of their budgets and work substantial hardships. Inflation by this measure was up 1.2% last month.


In 1982, the Bureau of Labor Statistics changed the way it calculated the housing component of the CPI. Prior to1982, the housing piece of the CPI actually reflected the price of houses and mortgage costs. But in 1982, the CPI began using a figure called the “owner’s equivalent rent of a primary residence.” [ii] In other words, the CPI swapped the cost of house ownership to the cost of renting. By carving out the cost of home ownership, this change had the effect of lowering the CPI. If you popped the actual costs of home ownership back into the equation, the CPI would be running at 5.6%.

Most people would believe that the reported CPI, core or non-core, understates the costs of what they buy. And the Author believes that the CPI does somewhat understate the price increase Americans pay.

Hedonic Regression and the American Clothes Dryer

Hedonic regression is less pleasureful than one could imagine. It is an adjustment in the CPI to reflect quality increases in the underlying market basket goods. But it is a Sunday morning after church and the Author’s brain is not up to explaining this concept. In fact, he barely understands it. A recent paper put out by the Bureau of Labor Statistics discusses hoe hedonic regression was used to weighting of clothes dryers in the Major Appliance component of the CPI.


[i] Even the semi-comatose readers of this Blog should realize that the phrase “Sounds simple, right?” is a trite attempt by the Author to tell you it is not simple. The Author should really read Ashlee Simpson’s autobiography to get more literary device ideas.
[ii]“Smoothing Out Inflation”, John Mauldin, The reasoning behind this change is based upon the theory that home owners are “buying an asset and leasing it back to themselves.”


Post a Comment

Subscribe to Post Comments [Atom]

<< Home