Wednesday, July 23, 2008

Setting the CPI straight

This is an expanded version of a semi-relevant post I made on Menzie Chinn's Econbrowser post, where I list what is wrong with the CPI, the commonly-cited measure of inflation, and what should be done about it.

1) Why include rarely-purchased things in the CPI at all? If home prices double, that doesn't change my mortgage payments. (Rents, which do regularly shift for those paying them, are a different story.) If iPods can now store twices as much for the same price, that doesn't do anything for me until I replace mine in two years. It does even less if price increases keep me from making that purchase altogether.

2) About hedonic adjustments: Here, I'll have to admit not having done my research here, and the wikipedia article wasn't much help. In order to do such an adjustment, you'd have to look at the product and measure various characteristics about it, which doesn't sound like something the relevant commissinos have labs for.

Example: I've noticed cereal boxes have gotten flimsier and thus hard to hold. I know this wasn't done because the flimsiness is a hugely sought-after thang. It was because that's cheaper. In doing so, they gored my consumer surplus. Though still worth buying -- because I like cereal -- the box is worth a lot less to me. Was this factored into cereal prices?

Without lifting a finger to do research, I'm guessing the answer is somewhere between "no" and "HAHAHAHAHA! Good one!"

So then, do hedonic adjustments ever result in inflation being stated as being *higher* because quality went *down*? If no, that means they should be discarded altogether. Don't subtract quality improvements unless you're going to add quality degradations.

3) Why don't they compile an "insulin index" as a way to measure the impact of the money supply on general price levels? Insulin is a necessary product for diabetics, who use it to sustain their existence, consciousness, and general health. It is the only product I know of to meet all of the following conditions:

-Has a very fixed, inelastic demand.
-Has many inputs, making it unaffected by local supply shocks.
-Can't be degraded in response to more expensive overall inputs, since it needs to meet a medical standard, thus preventing inflation from being hidden.

I haven't been able to find such an index.

4) Not so much a CPI issue, but why have your "core" inflation measure be one that outright excludes the very vital food and energy from it?

Yes, food and energy are deceptively volatile.
No, that's not a good enough excuse when we have such mathematical tools as a "RUNNING AVERAGE" that allows you to eliminate short-term volatility, while also accounting for when those prices go up and stay there.


Robert Wenzel said...


Are you aware that the "Core Inflation Index" was created by then-Fed Charman Arthur Burns at the behest of Richard Nixon in an attempt to fool the public as to the severity of inflation?

Silas Barta said...

Didn't know that, but that sounds about right. Thanks Robert!