MSNMoney: Fake Inflation Numbers Mask Crisis?

[wildman]

I found an article on MSNMoney and I am wondering what you knowledgeable people think of it:

http://articles.moneycentral.msn.co...nal/fake-inflation-numbers-masked-crisis.aspx

Is this guy right? Is he wrong? Is he a kook? Thanks for the feedback to a person who doesn't really understand all this stuff.

 

[mgb_phys]

Official inflation rates are underestimated by a factor of 2-3x.
The inflation is based on the rise in prices of a basket of goods bought by the average consumer - you can rig the figures by simply what you include in the basket.
In the UK for example the official inflation rate doesn't include mortgage/rent (because houses are an investment not a cost!) or fuel costs (because they change so much) or taxes. They do include major purchases like a flat screen TV.

So if your mortgage doubles because of interest rates, your council tax goes up, your fuel and electric bill increase 20% and petrol prices go up 30% - but Walmart introduce a $99 cheaper LCD TV then the inflation rate goes down.

 

[russ_watters]

This issue has been brought up before, but anyway...

Right or wrong about what? The article contains some facts and some opinions.

-It is factually true that the way inflation is calculated is adjusted due to technology.
-It is true that this practice is highly subjective.
-It is his opinion that this practice is improper.
-I hadn't heard about the housing price calculation (tied to rent, not purchase prices), but I'll assume it is true.
-It is his opinion that this practice is improper.
-It is his opinion that these contributed to the tech crash and the current financial crisis.
I disagree with those opinions.
-He mentions that in the '90s another factor was added, substitution: I agree that this practice is improper.

Now, the arguments:
He argues that the low calculated inflation rate contributed to the housing bubble. Maybe, but with or without the low inflation rate, the interest rate was absurdly/stupidly low. At the same time, the other flaws in the banking system that led to the bubble and crash didn't have anything to do with inflation. So that argument is very thin: maybe it's 10% of the cause, but no more than that.

I don't see any arguments discussing the '90s tech market boom, unless that's this:

But even reversing the adjustments that have distorted the official inflation figures won't fix the basic problem with the way we calculate inflation. Think of this: If the price of a can of soup goes up 10 cents, that's inflation, but if the price of a stock soars by 100%, that doesn't count as inflation at all.

It seems he is saying that the stock market should be factored into inflation. Well that's just silly. A company is not a product. Microsoft stock is worth 100x (made-up number) more than in 1985 because the company is 100x bigger (made-up number). And maybe that explains his position on hedonics: if that can of soup got 100x more expensive and also 100x bigger, he'd probably expect that the entire price should be factored into inflation.

Also, a speculative bubble in a market is a completely different animal than inflation. Note also, this "flaw" has always existed, so why does it cahse problems now where it apparently didn't before?

Also, calling the inflation numbers "fake" is at best yellow journalism. Any measure of inflation is going to contain subjective judgements. Whether one is better than another doesn't make the other "fake".

 

[russ_watters]

Official inflation rates are underestimated by a factor of 2-3x.
The inflation is based on the rise in prices of a basket of goods bought by the average consumer - you can rig the figures by simply what you include in the basket.
In the UK for example the official inflation rate doesn't include mortgage/rent (because houses are an investment not a cost!) or fuel costs (because they change so much) or taxes. They do include major purchases like a flat screen TV.

So if your mortgage doubles because of interest rates, your council tax goes up, your fuel and electric bill increase 20% and petrol prices go up 30% - but Walmart introduce a $99 cheaper LCD TV then the inflation rate goes down.

All that means is that inflation isn't a measure of what you think it should be a measure of. Inflation is a measure of the rise in prices of goods and services in an economy. It is a measure of the purchasing power of disposable income and it is measured in such a way as to make the numbers comparable from one year to another. Taxes are not a good or service. A house is arguable, but a house is not a consumable nor does it depreciate, so it is much different from a can of soup or LCD TV. Commodities like fuels are tough because of the fluctuations. Sure, they effect your bottom line, but if you include them, inflation numbers become worthless. Inflation is hugely positive one month/year and hugely negative the next.

No matter how it is measured, people just need to understand that it isn't perfect and there are other things that need to be considered. They need to accept it for what it is, not try to use it for/make it something that it is not. That's the way all statistics are.

 

[WhoWee]

As related to inflation, currently, the most important component is fuel. When gasoline moves from the $2.79 range to over $4.00 and back to $1.49 within a year...the impact has to be defined specifically or the results may not be accurate.

 

[russ_watters]

As related to inflation, currently, the most important component is fuel. When gasoline moves from the $2.79 range to over $4.00 and back to $1.49 within a year...the impact has to be defined specifically or the results may not be accurate.

Part of the problem is that it isn't uniformely spread over the whole economy. A person who drives 30 miles to work gets hit much harder than someone who drives 10. My house uses propane heat and propane's price swings with the oil price - but someone who has electric heat has a cost that has been basically capped for a decade.

Comodity prices are however, reflected in the prices of products, so they do still show up in the CPI.

 

[wildman]

Thanks Russ. What you say makes sense. Sorry if I restarted something that was already discussed.

 

[Art]

The central thrust of the argument in the article referenced in the OP is correct.

Understating the inflation rate led to the gov't pursuing a flawed economic policy in regard to interest rates. Instead of increasing rates to cool down a rapidly over-heating economy the gov't was lowering them adding fuel to the fire. This led directly to the housing bubble which in turn led to the credit crunch which has led to the current economic crisis.

One key reason why the gov't would have an interest in understating inflation is to keep wage claims down as these are inevitably tied to the CPI as are many index linked pensions.

 

[russ_watters]

Thanks Russ. What you say makes sense. Sorry if I restarted something that was already discussed.

The discussion of it before was pretty thin anyway. There are certainly people who would disagree with me and agree with the author, though...