Inflation: why it seems understated

[ladelfina]

I made this new thread as a follow-up to:
http://www.early-retirement.org/forums/f28/interesting-look-inflation-34941.html
because I would like to emphasize a certain twist that may have been underappreciated there.

I came across this post today:
The Big Picture | Inflation Ex-Inflation Ex-Inflation

Basically, the twist is that inflation for the country as a whole is 'correctly' measured, but the alarming growth in income disparity is responsible for figures that may seem to come from a fairy-tale. It's because they DO come from a fairy-tale; the spending of the princes and princesses is so much larger, and so much unlike, the spending of the average American, that the average figures no longer reflect the average reality as closely as they may have in the '50s/'60s/'70s. As this disconnect grows, CPI figures will continue to be more and more inaccurate for the practical purposes of mere mortals.

Food is registered as 7.6% of CPI.. yet

all but the top 20% of earners spend at least 20% of their paychecks on food.

This situation was probably alluded to on the previous thread, but I thought it deserved being brought out from the flurry of impressions and anecdotal sparring into a realm with some real numbers.

 

[FUEGO]

Now, let's not mislead folks by posting misleading blogs (misleading stuff on the internet??!! the horror!). The CPI-U actually consists of 7.7% food eaten at home and another 6.2% for food eaten away from home. In other words, 13.9% of CPI-U is spending on food. Not the 7.6% that the blog linked to here would suggest. Sensationalism?

To put these numbers in perspective, let's consider a middle class family. Let's say they spend $40000 per year. That means they would spend $257 per month on food eaten at home and $207 per month on food eaten away from home. Or $464 per month total on food. That is certainly proportional to my own personal experience.

 

[ladelfina]

FUEGO.. you're right that we should compare all food to all food. Too bad the linked article does not cite the 20% source. I will try to check what that is referring to.

added--
The closest I could come was this:
ftp://ftp.bls.gov/pub/special.requests/ce/share/2006/quintile.txt

Which does not show as huge a difference as implied in the first linked post.. but does have all food ranging from 15.9% (2nd quintile) to 10.9% (highest income quintile).

An interesting table to explore further.. thanks for pushing back!

 

[W2R]

FUEGO.. you're right that we should compare all food to all food. Too bad the linked article does not cite the 20% source. I will try to check what that is referring to.

added--
The closest I could come was this:
ftp://ftp.bls.gov/pub/special.requests/ce/share/2006/quintile.txt

Which does not show as huge a difference as implied in the first linked post.. but does have all food ranging from 15.9% (2nd quintile) to 10.9% (highest income quintile).

An interesting table to explore further.. thanks for pushing back!

I think that's 15.9% (lowest income quintile) to 10.9% (highest income quintile), since the first column is "All". The quintiles are, from lowest to highest, 15.6%, 14.3%, 13.5%, 12.9%, 10.9%.

So, if these are correct and if the CPI-U allows 13.9% for food, to me that seems reasonable. I must admit that I am surprised! But then, the BLS is where the CPI-U comes from, as I recall.

Also, the Consumer Expenditure Survey figures for income expenditure on food, by quintile, do not appear to include separate figures for those of us single women who (oh, the humanity!) might often allow our companions/boyfriends to take us out on Saturday night for a dinner date.

 

[FUEGO]

From what I have seen of the CPI, it is a very detailed system of determining price changes in a basket of goods. Hedonistic adjustments and substitutions are well documented and explained. It isn't a good measure of every single person's change in cost of living, but for a "typical" person (as measured by their defined basket of goods), it is a good measure.

If you track your expenses and know you spend more on some categories and less on others, the BLS suggests that you take the price changes in each category and determine your own weighted CPI.

 

[FUEGO]

Also, the Consumer Expenditure Survey figures for income expenditure on food, by quintile, do not appear to include separate figures for those of us single women who (oh, the humanity!) might often allow our companions/boyfriends to take us out on Saturday night for a dinner date.

Correct - you would need to look at the changes for each component of spending and weight it according to your own breakdown of spending.

 

[Leonidas]

The blog post is based on an article by Bill Fleckenstein. Isn't that the guy who has been an ultra-bear doomsayer on just about everything for years? If I remember correctly, he was shorting Google when it was sub-200 three years or so ago. Ran across some of his writing in the last year and looked at his track record on predictions - it was pretty miserable.

 

[W2R]

Also, the Consumer Expenditure Survey figures for income expenditure on food, by quintile, do not appear to include separate figures for those of us single women who (oh, the humanity!) might often allow our companions/boyfriends to take us out on Saturday night for a dinner date.

Correct - you would need to look at the changes for each component of spending and weight it according to your own breakdown of spending.

Right - - they don't bother to do it in computing their averages, thank goodness! That would be a lot of nickel and diming that wouldn't amount to a hill of beans, I agree, especially since someone who doesn't think they are in a fair and balanced relationship would have the common sense to get out (if they have any self respect). Thanks for clearing THAT up.

 

[clifp]

Basically, the twist is that inflation for the country as a whole is 'correctly' measured, but the alarming growth in income disparity is responsible for figures that may seem to come from a fairy-tale. It's because they DO come from a fairy-tale; the spending of the princes and princesses is so much larger, and so much unlike, the spending of the average American, that the average figures no longer reflect the average reality as closely as they may have in the '50s/'60s/'70s. As this disconnect grows, CPI figures will continue to be more and more inaccurate for the practical purposes of mere mortals.

Food is registered as 7.6% of CPI.. yet

I think there is probably some truth in your general hypothesis that increase spending but the top 20% screw up the average expenditures for the remaining 80%. Although I think food probably isn't a great example. As people get wealthier they switch to more expensive food, and far more importantly more eating out at nice restaurants. So the 15% for food and beverages seems roughly right. American have historically always spent less on food than other countries, for a couple of reasons. First we are wealthy country, and secondly American farmers are far more productive than the rest of the world and we have a very efficient food distribution network.

 

[MichaelB]

Price and economic indicators are intended for analysis at an aggregate, economy-wide basis and are not useful indicators of individual impact. They are also more meaningful when applied over longer periods of time - decades rather than years.

Regarding the OP, it would be interesting to see food expenditures - and shelter, and transportation - by income quintile , laid out by decade for the past 50 years or so.

The 20% of income number seems to have originated with Marc Faber - quite opinionated but hardly a neutral, scholarly voice in the inflation debate.

It would also be interesting to see the total caloric intake for income spent compared with post-WW1 era. I suspect we might draw different conclusions - as in less income spend on food, especially in the lower quintiles.

Michael

 

[pedorrero]

Let me speak for the cynic: a skeptic would think that the government would want to sugar-coat the problem of inflation, even if that means issuing misleading or even outright fictitious inflation figures. It just serves their interests to doctor the truth. Sorry, but that's the way politics works. E.g. my health premium just went up roughly 20% -- lessee, that's a bit more than the 4% or whatever the official figure is, isn't it?

 

[FUEGO]

E.g. my health premium just went up roughly 20% -- lessee, that's a bit more than the 4% or whatever the official figure is, isn't it?

Correct - you would need to look at the changes for each component of spending and weight it according to your own breakdown of spending.

It is very clearly spelled out on the BLS website for CPI that in order to get a customized estimate of your personal CPI, you must do the math.

 

[barbarus]

"This is of course why a focus on prices, especially the CPI, is dead wrong. The CPI is not a valid measure of inflation. No measurement of prices is a valid measurement of inflation.

It doesn't matter what you call inflation. What matters is the cost of living, in other words cost of consumption, which CPI estimates, or would estimate if it were done properly.

By definition, nobody has to buy any assets, including houses, ever.
People have to buy consumables. Those are the prices that matter, whether you call consumer price increases inflation or not."


This is a quote of someone from another site. It represents rather well the practical concept that I would like to express. Whether or not the technical definition of inflation is met, the on-the-ground experience of most people is that they are rapidly losing financial ground.
That is a situation that effects even the most well to do visitors of this blog.

 

[MichaelB]

Whether or not the technical definition of inflation is met, the on-the-ground experience of most people is that they are rapidly losing financial ground.
That is a situation that effects even the most well to do visitors of this blog.

Compared with what, and when?

Compared with 20 years ago, most folks didn't have cell phones, computers, high speed broadband connections or cable tv subscriptions. Certainly lower car ownership as well. If we only look at those things that have higher prices, there will always be understated inflation.

It also may be that an individual is losing ground but the country is not. This is not inflation - it is an individual loss.

Michael

 

[nepo]

Costs of items as percent of income becomes quite interesting when the country's saving rate is practically negative. For example:

By ELLEN SIMON, AP Business Writer Tue May 13, 12:06 AM ET

NEW YORK - The economic downturn is hitting roughly one in 10 middle-aged and older Americans especially hard, compelling them to borrow money for everyday living expenses and to seek help from family, friends or charities, according to a survey released Tuesday by the AARP.

In the telephone survey of 1,002 adults 45 and older, nearly four in 10 said they had helped a child pay bills or expenses. Among retirees, one-third said they'd helped their children pay bills. Eight percent said they'd helped a parent pay bills or expenses. The survey's margin of sampling error was plus or minus 3 percentage points.

One-third of survey participants said they stopped putting money into their 401(k) or retirement account and 14 percent said they had cut back on their medications.

"We have patients coming in fewer times," said registered nurse Tucky Franz of Salisbury, Md. "They'll cut back because of the copay."

The majority of baby boomers said they were finding it more difficult to pay for essentials and utilities, and six in 10 said they had cut back on eating out and entertainment.

 

[ladelfina]

You can diss the origins of the OP link.. I never heard of the two guys cited before so had no pre-conceived notions. The original link might still be worthwhile as there are ongoing comments there that expand the discussion as is happening here.

W2R, you're right.. while scrolling I missed the header and interpreted the first number as the lowest quintile. In fact, I scratched my head over the discontinuity but the correct reading makes linear sense: 15.6%, 14.3%, 13.5%, 12.9%, 10.9%.

Whatever the discrepancies I still think the general concern about skewing is valid.

It also may be that an individual is losing ground but the country is not. This is not inflation - it is an individual loss.

HA!

BRIAN: You've got to think for yourselves. You're all individuals!
FOLLOWERS:
Yes, we're all individuals!
BRIAN:
You're all different!
FOLLOWERS:
Yes, we are all different!
DENNIS:
I'm not.

Michael.. taken to its natural limit, then.. you're happy if Bill Gates alone pays less for whatever it is he buys (I hear yachts and so forth can now be had cheaply) even if tens of millions find what they buy more expensive? Since it all "evens out"? I understand and even agree with a lot of libertarian principles, but we live in an eternal human society where impoverishment and unrest have economic tolls, as well.

I came across a comment -that I can't find now- on PIRATES (Arrrgggh!) and how they had a co-operative system that shared the booty. Otherwise their society could have never held.

 

[CuppaJoe]

...figures that may seem to come from a fairy-tale. It's because they DO come from a fairy-tale; the spending of the princes and princesses is so much larger, and so much unlike, the spending of the average American, that the average figures no longer reflect the average reality as closely as they may have in the '50s/'60s/'70s. As this disconnect grows, CPI figures will continue to be more and more inaccurate for the practical purposes of mere mortals.

all but the top 20% of earners spend at least 20% of their income on food.

....

Interesting, LaDelfina. Here's an unscientific observation that has bothered me for many years: On my j*b, I see breakdowns of income and expenses for "princes and princesses" aka, high net worth and/or high income folks. The numbers that often jump out at me are the "food at home" and "eating out" categories; not only are the numbers low by percentage of their total expenses but they come in low relative to what I spend. My theories as to why this is go from: 1) the numbers are wrong; 2) the guy or gal is a work-alcoholic and takes most meals at the company cafeteria; 3) many meals are treated as business expenses; 4) s/he is a "social X-ray" ala Tom Wolfe’s characters in "Bonfire of the Vanities," 5) s/he attends many benefits and social events with food supplied, and their own entertainment expenses which include catering would appear separate from food expenses; and 6) other.

 

[MichaelB]

Michael.. taken to its natural limit, then.. you're happy if Bill Gates alone pays less for whatever it is he buys (I hear yachts and so forth can now be had cheaply) even if tens of millions find what they buy more expensive? Since it all "evens out"? I understand and even agree with a lot of libertarian principles, but we live in an eternal human society where impoverishment and unrest have economic tolls, as well.

?

I am not at all suggesting there is no inflation, nor am I siding with Ayn Rand. My points are:

CPI is worthless as a measure of individual inflation
Inflation measures are really most valuable when seen over long periods of time and at the macro level.
A more rigorous discussion of inflation needs a baseline and a framework, not an outburst of individual perception
In the US we are spending less on food (as a % of income) than anyone else in the world and less than at any other time in our history
Inadequate nutrition in the US is the result of poor habits and not expensive food. The same was not true until very recently - 1-2 decades.

Individual perception is probably the worst way to "measure" this, because it lacks objectivity and begins with a predetermined conclusion.

There also may be an institutional bias toward understating some aspects of cost of living, but there also may be other bias toward the opposite, and the end effect is not clear. There is clearly a problem of income distribution and lagging incomes, much of which has been compensated with more people x household working and more credit. From the original thread, one important point implicit in E Warren's work is that many people spend their money poorly - and cannot cope easily with changing prices.

Michael



This entire subject lends itself to the tin foil hat community (aluminum foil beany for some).

 

[ladelfina]

joe, how 'bout "all of the above"? My bet is on 3/4/5 mostly.

Not really germane to this discussion, but did you ever notice how the absolute RICHEST celebrities and so forth seem to get comped quite a lot? Do you think Paris Hilton (despite her undoubtedly free lifetime supply of Carl's Jr. cheeseburgers) EVER needs to actually pay for a meal? (Not that she would eat much..) but I'm sure that goes for the Donald and other rich personalities. I bet all they have to do is walk into certain restaurants and they'll get a meal on the house as likely as not. Works with clothes, too.

added:

This entire subject lends itself to the tin foil hat community (aluminum foil beany for some).

Thanks! You're not the first, so I'm taking that as a compliment.

If you think this doesn't affect you in some way or other, you're wrong. You may feel yourself to be a beneficiary of artificially low CPI visions if you don't have a COLA pension or plan on taking SS, for example. But there are others here (I am not one) who are, or will be, counting on one or both of those income sources, and may feel they are getting short-changed. That's just the most obvious repercussion but there are others. -- Wage raises and leases can be linked to CPI. Bonds and even arcane GSE structured credit swap thingies use the CPI as a metric. If you are on the wrong side of the deal (like with inflation-linked bonds now) you are in NEGATIVE earning territory. Base your life on trusting the CPI figures and you may consider yourself lucky to have a tinfoil hat, instead of one made of dryer lint!

 

[RockOn]

?This entire subject lends itself to the tin foil hat community (aluminum foil beany for some).

Are you feeling a little defensive? Just wondering......

Does one have to be a certified card carrying member of the the plunge protection team to have the imagination to claim the reported CPI is representative of an average American? Just wondering........

 

[CuppaJoe]

joe, how 'bout "all of the above"? My bet is on 3/4/5 mostly....

My favorite is No. 1 (the numbers are wrong).

 

[ladelfina]

one important point implicit in E Warren's work is that many people spend their money poorly

Michael I can only imagine you didn't watch the presentation if that is what you took away from it. You could have just stuck with the common media meme and saved yourself the hour. Sorry to be blunt. You may care to re-visit the presentation because it posits exactly the opposite, in large part.

People are not somehow wildly smarter or wildly more stupid from generation to generation. If they make certain choices there are reasons behind it, even if in the moment they can't always predict the political and economic changes ahead that may compromise their current standing. We are talking about the vast majority, not the lowest end of the bell curve.


Joe, do you care to share (even in veiled way) how you arrive at #1? Are the prince/princess figures that you review self-reported? How exactly do you come to see them?

 

[DJRR]

Basically, the twist is that inflation for the country as a whole is 'correctly' measured, but the alarming growth in income disparity is responsible for figures that may seem to come from a fairy-tale. It's because they DO come from a fairy-tale; the spending of the princes and princesses is so much larger, and so much unlike, the spending of the average American, that the average figures no longer reflect the average reality as closely as they may have in the '50s/'60s/'70s. As this disconnect grows, CPI figures will continue to be more and more inaccurate for the practical purposes of mere mortals.

I somewhat relate to this. On a macro level I received a 4% pay raise this year and perceive no change in my standard of living, so I think that inflation is probably 3-4% overall. Some of my bills went up, but I got a smokin deal on Verizon Fios, etc. If "true" inflation were running more than double my paycheck I would notice a marked decrease in my standard of living.

On the other side, I use about 750 gallons of gas a year. If gas goes up $1 a gallon from $3-$4, that is not even 1% of my income. A 33% increase in gas barely registers to my budget. If I had a lower income and was using 2x the gas then I would be really hurting. Same with food costs. I shop at Costco in bulk, grocery stores on sale, restaurants with coupons, and bring my lunch to work. I pay 3.29 a gallon for milk at Costco, but others pay 3.99 at the grocery store or 4.50 at 7-11. Why? It is the same exact product. Meat costs were down, so I substituted more meat. I don't eat rice so I could care less what it costs, etc. The whole discussion is highly individualized based on your habits and preferences.

 

[CuppaJoe]

....
Joe, do you care to share (even in veiled way) how you arrive at #1? Are the prince/princess figures that you review self-reported? How exactly do you come to see them?

I'm possibly wrong to even think of no. 1 (the numbers are wrong). But early on I did help people fill out the forms (I'm happy not to do that anymore), and that was my take, I would hold back from asking if they were sure about the food numbers. The rest of their numbers always looked ok.

Let's just say that I give the breakdowns some credence because they are signed "under penalty of perjury." We don't get that in surveys.

----
My number 1 is sort of a joke because IMO so are the CPI numbers possibly wrong or understated.

 

[Abreutime]

Very good article about our biases in observing the inflation numbers

Seeing Inflation Only in the Prices That Go Up - New York Times