Sumner: Has CPI Been Wildly Overstating Inflation?

Scott Sumner makes a very good point (though my interest here is somewhat peripheral to the main thrust of his post):

Government price indices don’t measure the prices that are of macroeconomic interest.  For instance in the 6 years after the housing bubble peaked the US, BLS data shows housing prices rising by about 10%, while Case-Shiller showed a 35% decline.  Housing is 39% of the core CPI.  That’s a big deal.

Here’s what that looks like:

Yow. (The important CPI sub-components of housing, i.e. owner equivalent rent, look similar.)

Contra the sky-is-falling inflationistas at ShadowStats, this suggests that CPI has greatly overstated inflation since the (Shiller) housing peak in April 2006. Just for illumination, here’s a rough-and-ready shot at replacing the 40% of housing movement in the CPI with the movement we see in Case-Shiller:

Screen shot 2013-09-04 at 5.29.48 PM

If this has any merit, we’re looking back at three to six years of deflation. It also suggest that inflation has been shooting up in the last year or so. Do with that what you will.

Paul Krugman often defends CPI against ShadowStats-style attacks by pointing to the Billion Price Index, which tracks closely with CPI over time. But the BPI is an index of retail prices. It doesn’t include housing, health care, education, and many other components that make up more than 50% of the Consumer Price Index. (Which makes you wonder why CPI and BPI track so closely…)

I notice that this Sumner item caught Karl Smith’s eye as well, and he points out rightly that constructing indexes is always a problematic venture:

basically anyone with MS Excel and a rudimentary knowledge of the subject matter in question can create a workable index

But, still, based on this quick look, at least since the housing peak in 2006, Scott’s right that CPI has been looking like an especially dicey measure.

Cross-posted at Angry Bear.






3 responses to “Sumner: Has CPI Been Wildly Overstating Inflation?”

  1. Tom Hickey Avatar

    Inflation can’t be measured precisely since there is no observable price level. The price level is an index and an index is an arbitrary figure that could be arrived at through different paths and rationales.

    What is important is the rate of change of a constructed price level, so if the index is figured the same way each period, then a rate of change for that index can be computed and used to measure actual changes in purchasing power in contrast to the apparent rate that volatility of some goods suggests. While the price level constructed is an arbitrary figure, it’s action is not as long as measurement of the variables over time is reliably accurate.

    However, data collection in the case of economic data is not the result of direct observation as in the natural sciences either. Economics is a social science and the data is much looser. Some important economic data is anecdotal rather than observational.

    Inflation is a bogus measure when applied beyond the limits of the data, which is most of the time historically and even today in countries without adequate institutional arrangements for data collection and processing. Inflation rates extending back centuries in historical studies are usually presumed to be true. On what basis?

    The US is a leader in the field of economic data, and to suggest that its agencies get the data wrong or misconstruct it (Sumner), or manipulate the data for political purposes (Jack Welch) is to suggest that the data upon which macro analysis is founded is garbage. Ergo, macro analysis is GIGO. The question is, How true is that? It’s a question I have been pondering for some time. It seems to me that a lot a macro analysis may be GIGO, such as Reinhart & Rogoff turned out to be on critical analysis.

    Then there’s Robert Eisner’s work on national accounting, which also suggests that data is misconstructed and misinterpreted based on the institutional construction and interpretation of national accounting, e.g, in comparison with firm accounting. As a result the reported fiscal balance may not represent the actual fiscal stance, and so politicians are misguided in relying on it to formulate economic policy.

    Is there a pernicious tendency to take reported figures for constructs like price index and fiscal balance as exact when they are only estimates or best guesses? Enquiring minds would like to know.

    Same goes for medical studies for medications and procedures, as anyone who has had the occasion to question one’s physician on specific recommendation and knows what questions to ask comes to realize. Are consumers generally too trusting of physicians recommendations? My conclusion from experience is yes.

    There’s a lot of flying by the seat of the pants that gets swept under the rug of conscious awareness in the presumption of a degree of exactitude that is non-existent.