The Consumer Price Index is a measure of the change in prices consumers pay for different goods over time, and is often used as a benchmark for inflation. However, the inflation levels it suggests are not without controversy, and are often accused of being over- or understated. So what is the truth? And why would it be either?
No, inflation is overstated
Various biases cause inflation to be continually overstated.
The 'theoretical fixed basket' does not reflect what people buy
When prices rise, consumers buy cheaper goods rather than higher priced goods.
Shift in what is relevant to the CPI
Technological change means that many things we used to pay for are now free.
Rise in quality causes inflation to be overstated
Quality improves over time, and adjusting for quality means consumers get more for less.
Inflation is accurate, but ignores varying demand elasticity among its components
The fastest-inflating components of CPI are demand inelastic. You can delay or decline a TV purchase, but not a hospital stay. Demand-inelastic items therefore consume an ever larger proportion of the consumer budget. This is most noticeable to lower-income consumers, who perceive a creeping loss of financial control, even if their total spending is growing only slowly.
Yes, inflation is understated
The government has a vested interest in inflation being understated, and the data it is based on it largely theoretical.
The Government ensures inflation is understated
The government has a vested interest in understating inflation because payments are tied to it.
Quality adjustments cause inflation to be understated
Quality adjustments may account for improvements in standards of living, but the consumer doesn’t pay lower prices.
Inflation indices do not reflect reality
Much of the inflation basket is theoretical and not based on increases in price.
Inflation is multi-dimensional.
Representative basket of goods varies by geography and income bracket. There should be thus multiple inflation numbers reflecting this.
This page was last edited on Tuesday, 28 Jan 2020 at 12:08 UTC