Policymakers Claim Inflation Overstated—CPI Revision in the Works

Co-Authored by Tony Danaher

A week ago it was reported that the U.S. Social Security Fund was destined to run out of money sooner than anticipated. The reports cited several contributing factors, such as lower employment levels, payroll tax cuts, increased disability claims (which we discussed in last week's commentary - April 26th), and inflation. So, what shows up in Bloomberg BusinessWeek this past weekend? An article saying that lawmakers from both sides of the aisle believe that inflation is overstated, and that a move to further change the Consumer Price Index (CPI) is in the works.

This is typical behavior by government, and such a change would mean yet another major adjustment to add to those already made in the CPI over the last few decades. Just like the previous changes that have been made to the way inflation is computed, the desired effect of this one would be to try to hoodwink the public into believing that inflation is lower than it is. If you didn't think statistical analysis was subject to magical alteration, please read on.

First, let's review the situation. The CPI's importance to the economy cannot be over emphasized. It's the benchmark that determines the cost of living adjustments for pensions, tax policy, and many government programs. It also represents a benchmark used in utility price setting, real estate contracts, and many other business dealings throughout the private sector.

There is a move in Washington to adopt a measure called "chained CPI", which takes into consideration the habit of shoppers to substitute one item for a similar, lower-priced item. The BusinessWeek article states that changing the calculation is "a long-overdue piece of important business that can and should get done". The perspective this article takes is that fixing the CPI would "yield immediate savings" to the government, "and put the economy on firmer ground".

We say: Let's tell the truth. The real-life effects of this change would be a hard slap in the face to savers and retirees.

It is a fact that a lower CPI figure helps the government in many ways. It is also a fact that an artificially lower CPI penalizes savers, and those whose income depends upon inflation indexing, employees and businesses that get cost-of-living adjustments, and retirees living on social security or other programs that are indexed to CPI. Over the past thirty years, the CPI inflation calculation has been modified several times, and it almost always results in an understatement of what we believe to be realistic price increases. Why does it almost always indicate a lower rate of inflation? It seems that this is done to help the government, and ends up penalizing others. Draw your own conclusions from these facts. We have reached ours.

In recent years, when government reports GDP growth, the inflation figure is backed out. GDP is reported after inflation. This way, if someone wanted to exaggerate the growth of the economy--let's say, for political reasons--they might look for ways to reduce the official inflation rate. Of course, when policymakers want to justify future rounds of QE, a lower inflation rate is always helpful in making their case that inflation is low, so money printing is needed to stimulate the economy.

The current CPI basket is highly complex. The proposed changes will make it even more complex. This proposed manipulation or adjustment will make the CPI altogether more arbitrary, and give more power to government statisticians. If an item that is rising in price can be removed, and an item falling in price can be substituted for it, one can easily see how inflation data can be manipulated. Some would argue it will give government statisticians more leeway to show a CPI figure that politicians like. We call foul on this behavior.

Today's CPI basket includes about 80,000 items in total. Many of them would be considered luxuries, which provide little utility to large segments of the population. At Guild Investment Management, we dispute the need for the proposed adjustments. We believe that this is yet another ploy to make the government look better and has the effect of penalizing citizens. Our view is that, looking ahead, the path of least resistance for prices -- especially the prices of basic, essential needs like food, clothing, shelter, and energy -- is up. This is the case, regardless of what the proposed new adjustments to CPI may tell you.

It is because of the need for an unbiased view of the cost of basic needs that we created The Guild Basic Needs IndexTM. The GBNITM tracks the prices of a basket of items in the category of true needs for all of us: food, clothing, shelter, and energy. The price changes of underlying basic needs can take time to trickle through the economy, but eventually they pervade all prices. Regardless of what is done to adjust the CPI, any American who eats, wears clothes, drives, cooks, pays rent, or owns a home is likely to experience rising prices in the years to come. You can track the changing prices here in our letters.

Even though they may be more volatile than CPI, the prices of basic needs should be tracked as their impact will trickle through the economy.

About the Author

Chief Investment Officer
guild [at] guildinvestment [dot] com ()