CPI Composition

[PLOlover]

I just heard paul craig roberts, economist under reagan, father of "reaganomics", and he said the cpi underestimates true inflation, so you know, it's not just a bunch of "kooks" or whatever.

[DcifrThs]

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I just heard paul craig roberts, economist under reagan, father of "reaganomics", and he said the cpi underestimates true inflation, so you know, it's not just a bunch of "kooks" or whatever.

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i just finished reading studies that accused the CPI of overstating inflation.

the debate rages on for both sides of the issue (though i'd be more likely to think that understating is an issue vs. overstating)

either way, you can look at it and judge for yourself.

my overall point before hand though is that you can trust the market of academics to bemore informed than legislators and i thought it odd for borodog to quote a legislator rather than respected economists/journals etc.

just my thoughts.

personally, i doubt highly that if CPI is understated, it is done so on purpose.

Barron

[PLOlover]

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personally, i doubt highly that if CPI is understated, it is done so on purpose.

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well part of cpi assumes that people will lower their standard of living when facing rising prices, eg, if the price of beef goes up, according to cpi, people will switch to chicken.

so it seems to me that if you are on a fixed income tied to cpi, then you are assured a lower and lower standard of living, assuming generally rising prices (which they've been for the last what, 70 years at least).

do you agree with that?

[DcifrThs]

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well part of cpi assumes that people will lower their standard of living when facing rising prices

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can you cite where you got this from? i must have misse dit

assuming that is correct:

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so it seems to me that if you are on a fixed income tied to cpi, then you are assured a lower and lower standard of living, assuming generally rising prices (which they've been for the last what, 70 years at least).

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i dont think i agree iwth that on the face of it unless i've missed something, which is entirely possible. if you have a fixed income based on CPI, then the relative contribution of any individual item in CPI is inconsequential so long as what you say is correct.

if the income is tied to cpi (like bieng long an inflation linked bond), then your purchasing power will not change. you may have to adjust your consumption in reality (i.e. buy chicken instead of beef), but your overall consumption (absent utility) will not change.

you are not forced into a lower standard of living. you are forced into a totally stagnant living given your statements, assuming they are factual.

Barron

[PLOlover]

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if the income is tied to cpi (like bieng long an inflation linked bond), then your purchasing power will not change. you may have to adjust your consumption in reality (i.e. buy chicken instead of beef), but your overall consumption (absent utility) will not change.

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? I don't get it.

but look up hedonics. if food goes up 10% then the food section of cpi doesn't go up 10%, they adjust it to say 3%, because they figure people will buy cheaper food.
But if you are forced to buy cheaper food, aren't you lowering your standard of living? if you have to take the bus because a car is too expensive, aren't you lowering your standard of living? if a new tv is 250% more expensive but they only count it as 75% more expensive because it is better, then you're still not going to have enough money to buy a new tv if your old one breaks, etc.

My main point is that these things are cumulitive given that inflation is never negative, so that after 20 years someone on a fixed income cpi adjusted deal may have .5 to .75 the standard of living of when they started. I mean, you can only downgrade every year so much

[DcifrThs]

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if the income is tied to cpi (like bieng long an inflation linked bond), then your purchasing power will not change. you may have to adjust your consumption in reality (i.e. buy chicken instead of beef), but your overall consumption (absent utility) will not change.

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? I don't get it.

but look up hedonics. if food goes up 10% then the food section of cpi doesn't go up 10%, they adjust it to say 3%, because they figure people will buy cheaper food.
But if you are forced to buy cheaper food, aren't you lowering your standard of living? if you have to take the bus because a car is too expensive, aren't you lowering your standard of living? if a new tv is 250% more expensive but they only count it as 75% more expensive because it is better, then you're still not going to have enough money to buy a new tv if your old one breaks, etc.

My main point is that these things are cumulitive given that inflation is never negative, so that after 20 years someone on a fixed income cpi adjusted deal may have .5 to .75 the standard of living of when they started. I mean, you can only downgrade every year so much

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first off, know that we're dealing in averages here. if you are an average american w/ an income tied exactly to average CPI then the CPI applies to you. but the average is a poor descriptor of the individual. for some, it will mean that they are living better off and for others it will mean that they are living worse off as you point out. in some cases the differences will be quite extreme.

what you say makes sense if the bold part above is true.

can you cite where the CPI assumes that a rise in food prices isn't passed entirely through to the index?

if average milk prices increase 10% (and nothing else changes) and households overall report that as such, then the relative importance of milk will rise by 10% and food will increase by 10%*milk's contribution to food if my understanding of the CPI construction is sound.

cna you provide some cite to the contrary?

thanks,
Barron

[ItalianFX]

DcifrThs,

Interesting discussion. I just have a quick question. Could you point me to where Transportation is stated as 6?

Thanks.

[PLOlover]

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first off, know that we're dealing in averages here. if you are an average american w/ an income tied exactly to average CPI then the CPI applies to you. but the average is a poor descriptor of the individual. for some, it will mean that they are living better off and for others it will mean that they are living worse off as you point out. in some cases the differences will be quite extreme.

what you say makes sense if the bold part above is true.

can you cite where the CPI assumes that a rise in food prices isn't passed entirely through to the index?

if average milk prices increase 10% (and nothing else changes) and households overall report that as such, then the relative importance of milk will rise by 10% and food will increase by 10%*milk's contribution to food if my understanding of the CPI construction is sound.

cna you provide some cite to the contrary?

thanks,
Barron

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did you google hedonics?

http://www.atimes.com/atimes/Global_.../HF27Dj01.html
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However, in the early 1990s that transparent method of CPI calculation came under assault from Michael Boskin, then chief economist to the administration of US president George H W Bush, and Alan Greenspan, then chairman of the board of governors of the Federal Reserve System.

Their assertion was that the CPI calculation was much too simplistic and resulted in much too high a measure of inflation. They argued that the calculation needed to take into account the real-world phenomenon of substitution, whereby consumers who cannot afford more expensive items switch to buying the less expensive ones, and that the inflation calculation should switch to tracking the costs of the less expensive items whenever substitution was presumed to occur.

That generally would have required moving from the fixed basket of goods to a variable one, but initially, instead of that move the concept of weighting was introduced into the fixed basket in an effort to approximate the phenomenon of substitution.

Straight arithmetic weighting was gradually replaced by geometric weighting by 1999. In the geometric weighting favored by Boskin and Greenspan, the basket items with recently increasing ("volatile") prices receive less weight while those that decrease in price receive more weight. So the result is a lower overall number for inflation.

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http://en.wikipedia.org/wiki/Hedonic_regression
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Some economists have criticized the US government's use of hedonic regression in computing its CPI, fearing it can be used to mask the "true" inflation rate and thus lower the interest it must pay on Treasury Inflation-Protected Securities (TIPS) and Social Security cost of living adjustments.

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http://moneycentral.msn.com/content/P92951.asp
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Lastly, Gross points out who is penalized by this cheating: "They disserve, of course, all of those who receive Social Security, as well as other private pensioners dependent on an accurate accounting of prices paid. They disserve buyers and holders of TIPS -- inflation protected securities -- which adjust inadequately to a faulty and near fraudulently calculated CPI that one day could total billions of dollars per year for TIPS holders. And they disserve all owners of U.S. Treasury obligations -- including foreign central banks and institutions. . . ."

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