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What's the Real Inflation Rate?



July 02, 2014 – Comments (0) | RELATED TICKERS: BRK-A

Board: Berkshire Hathaway

Author: mungofitch

But whether that exceeds my experienced inflation rate (now around 10% for what I buy or must pay) or not, I worry about a lot.  I am not concerned much over the manifestly ridiculous official  inflation rate any more than I believe the current unemployment rates. ... I have said in the past that it seemed to me the current inflation rate  was 10% for me, not the 2% figure given by the government.

Different people have different meanings for the word "inflation." In a more technical sense it's always and everywhere a monetary effect resulting in a generalized rise in prices and wages. Emphasis on "generalized". It's a fall in the purchasing power of the currency and a partial failure of its ability to store value: the money supply growing faster than the supply of goods and services.

There isn't much more US money lately...the supply of money has risen at quite a low rate in recent years. (the Fed's balance sheet is irrelevant for this measure...if you want to know  the current temperature in the house, check a thermometer, not what the boiler is up to) Unsurprisingly, the US dollar has been a pretty good store of value in recent years.

A very separate effect, which is often felt strongly by a given individual, is the fact that at any given time a lot of prices are rising and a lot of prices are falling for product-specific reasons. Depending on the mix of goods of which you are a consumer, you will have wildly different perceptions of a rising cost of living. (a rising cost of living for a given individual, or even large group, is not in general the same as inflation). e.g., the fact that health care costs are rising rapidly in the US does not  indicate that the US dollar is failing as a store of value any more than the fact that CD players cost less is a sign that it is gaining and storing more value.

I think all the different figures you see are "right", just that they mean different things. The US dollar is *not* losing out as a general store of value at a rate  of 10%/year: inflation is definitely not anywhere near 10% in the  sense of the technical definition above. The ~2% figure is very plausible. Your cost of living may well be rising much faster than 10%/year. Those two things can both be entirely true at the same time.

I'm interested in generalized purchasing power of the currency, not the  personal experience of a particular class of US consumer. For that, the monetary/economist definition is the one that makes sense.

I think the best way to do that is to track the change of a basket of goods which are not changing rapidly in supply, demand, quality or price, even if they do not represent the basket that you personally are consuming. Historically there are things that have changed very slowly, and have as a result have been great trackers of general purchasing power. A first class stamp (even though it's regulated) A man's dress shirt (even though it's distorted recently by the globalization wave) The cost of a journeyman carpenter for a day (even with unions and regulation) A normal men's haircut An entry-level new film-based SLR camera (harder to find lately!) You could add other things. Say, a #2 restored 1965 Volkswagen Beetle or Ford Falcon. (new paint very good restored driver, not concours) The "breakfast mix": a pound of bacon, a loaf of bread, a quart of milk, a can of frozen orange juice, and a dozen eggs. Add in a can of Bud if you like : )

Incidentally, this idea of using a focus on things that aren't changing too much to get a feel of what the currency is doing (as opposed to what the consumer is experiencing) is very much in keeping with the change in methodology to use median rather than average item changes in the CPI methodology. The prices that are moving wildly are probably moving wildly for reasons of rapid changes in the supply or demand or quality of those goods, and specific to them. As a result those price movements, though perhaps very useful and relevant for other purposes, are probably saying almost nothing about the dollar as a store of value. As mentioned, that's the thing I'm interested in. I think the bigger argument against the change in the CPI measurement is not that it's "wrong" or "purposedly distorted" or "a lie" (though I'm sure all of those have a grain of truth), but mainly that it moved more  in the direction of being a good monetary measure and less in the  direction of measuring the experience of a mythical average Joe.

For people interested in the rise in the cost of the things they buy, I don't think any index has as much value as simply adding it up yourself : )

For those interested in the power of a US dollar to store value, a  standard all-cities headline CPI adjustment is pretty good.




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