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Q: The Real Rate of Inflation ( Answered,   2 Comments )
Subject: The Real Rate of Inflation
Category: Business and Money > Economics
Asked by: infoaristo-ga
List Price: $200.00
Posted: 15 Nov 2005 06:10 PST
Expires: 15 Dec 2005 06:10 PST
Question ID: 593212
CPI today has little correlation to with the rate of inflation. Items
like gas, building supplies and houses, which all went up at least 25%
this year(some did that in a month) are not included in it. New
methods of calculating inflation allow "cheating" in compiling the
figures by techniques like "hedonics" which allow ficticious prices to
be calculated for goods to compensate for new features, e.g. a $300 TV
now has picture in picture, it will be claimed the new feature is
worth $200 and therefore the TV is really worth $100, a price fall,
even though a $100 TV is not available to purchase. Guidelines allow
for prices of used goods to be substituted for the prices of new ones
if, for some reason, the price increase was "wrong" for that month.
Changes in inflation calculation just since the Clinton presidency
alone have reduced reported CPI rates by sevral percent.

My questions is:
What is the real rate of inflation and how can I track it?

Request for Question Clarification by nancylynn-ga on 16 Nov 2005 18:41 PST
Hello infoaristo-ga: 

I can't give you a definitive metric: "such-and-such is the
universally agreed-upon best way to measure inflation,"  but my
research has yielded essays and research papers that explore or
advocate alternatives to CPI.

Is that what you're looking for -- theories that explore or espouse
alternate methods?

Best regards,
Google Answers Researcher
Subject: Re: The Real Rate of Inflation
Answered By: pafalafa-ga on 18 Nov 2005 12:28 PST

Thanks for posting such a fascinating question.  

Inflation is one of those topics that is interesting to people from an
academic point of view, but also very much relevant to the person on
the street, in terms of their buying power for the money they have
available to spend.

We all sometimes react with surprise when the candy bar we bought as
kids for mere pennies now fetches a dollar or so, or when we can spend
five bucks on a cup of coffee!  Inflation is part of the story, for
sure.  But only a part...

The preface to your question has quite a few presumptions built
into...not all of which I agree with.  But before addressing those
presumptions, let's begin with a bit of an exploration of the term
"inflation" itself.

From the dictionary:


A persistent increase in the level of consumer prices or a persistent
decline in the purchasing power of money, caused by an increase in
available currency and credit beyond the proportion of available goods
and services.

A general increase in the price level of goods and services. 

1: a general and progressive increase in prices; "in inflation
everything gets more valuable except money" [syn: rising prices]

The overall general upward price movement of goods and services in an
economy, usually as measured by the Consumer Price Index and the
Producer Price Index. Over time, as the cost of goods and services
increase, the value of a dollar is going to fall because a person
won't be able to purchase as much with that dollar as he/she
previously could. While the annual rate of inflation has fluctuated
greatly over the last half century, ranging from nearly zero inflation
to 23% inflation, the Fed actively tries to maintain a specific rate
of inflation, which is usually 2-3% but can vary depending on


Though the definitions and explanations differ, the overall meaning is
fairly clear -- inflation is a general increase in the prices of goods
and service.  The more rapid the increase, the higher the overall rate
of inflation.

So far, so good.  

But now the question becomes:  What goods and services?  

And furthermore:  How can we quantify the amount of inflation?

In many respects, inflation is an experiential phenomenon, very much
tied to the actual lifestyle and purchasing habits of an individual
consumer.  A retired senior citizen with complex medical problems, for
instance, "feels" the impact of rising drug prices much more than a
healthy, working twenty-year old.  If pharmaceutical prices are rising
rapidly, then the senior citizen's experience of inflation is likely
to be quite different from the experience of the young worker.

Similarly, farmers have different spending patterns than urbanites.  A
clothes-horse spends differently than a slob; a gourmet differently
than Ronald McDonald.  My neighbor, who inherited his house from his
parents, is much less affected by changes in housing costs than are
the month-to-month renters who live down the block.

Nor is inflation just a matter of consumer experience.  Factories and
firms experience inflation as well.  Airplane companies were socked
hard by the recent spikes in the costs of fuel.  But for Exxon, Shell
and the other energy extraction companies, the price hikes didn't have
much of an impact on their overall cost of doing business.  Instead,
they were a welcome boost to their quarterly profits!

So if every person's and every organization's experience of inflation
is different, how, then, to arrive at an overall single measure of

This is where inflation indexes come into the picture, such as the
Consumer Price Index that you asked about.

The CPI is an attempt by the US government to answer all the above
questions.  The CPI creates a well-defined 'basket' of consumer goods
and services, and tracks changes in the costs of buying the basket
over time.  It is meant as a realistic indicator of the experience of
a typical American consumer.

In the course of doing so, the CPI has become one of the most
well-known indexes of inflation.  But it is certainly not the only
one, nor does anyone pretend that it is perfect.


Let me come back to your original question, and the presumptions I
alluded to.  I feel it is important to work through some of these
before coming to a final answer to your question.

>>CPI today has little correlation with the rate of inflation.<<

I don't know what you are basing this statement on, but I see no
reason to suppose that CPI is totally disconnected from the real
experience of inflation.

CPI isn't a perfect measure, true.  But the problem inherent in your
statement is that it presupposes that there IS, in fact, a single,
quantifiable 'rate of inflation'.  But since everyone's experience of
inflation is different -- depending on whether they are a person or an
organization, how they spend their money, how they adjust to price
changes, what their desires and priorities are as consumers -- then
there really isn't a single 'true' measure of inflation.

CPI is one (among a number) of commonly used measures to more or less
average out the experiences of thousands upon thousands of consumers. 
It is designed to reflect the experience of a typical, urban wage
earner.  As far as I can tell, it does a decent job of this.

>>Items like gas, building supplies and houses, which all went up at
least 25% this year(some did that in a month) are not included in

I'm not sure where you're getting your information.  Since CPI is
meant to reflect the experience of everyday consumer expenses, it
certainly DOES included things like gasoline, home heating costs, and
other day to day and month to month type expenses.  To the extent that
one goes to Home Depot or Lowes during the month and picks up building
supplies, that would be reflected too, though common sense tells us
that this would be a fairly minor expenses for most folks in any given
month (though it easily becomes a very large expense once one decides
to undertake that construction project they've been dreaming about for
the past ten years!).

Housing costs are a strange beast, since one does not generally buy a
house on a daily or monthly basis (though again, if you're a business
that buys and sells real estate, then your exposure to changing house
prices certainly is part of your experience regarding inflation).  To
the extent that rising real estate prices affect rents, though, this
is something else that is reflected in the CPI.

Actually, the major omission from the CPI in terms of expenses is
income tax (other taxes, like sales tax, are included, however). Nor
does it include investments.

You can read about what's in, and what's out, here:


7. What goods and services does the CPI cover?
The CPI represents all goods and services purchased for consumption by
the reference population (U or W) BLS has classified all expenditure
items into more than 200 categories, arranged into eight major groups.
Major groups and examples of categories in each are as follows:

FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine,
service meals and snacks)

HOUSING (rent of primary residence, owners' equivalent rent, fuel oil,
bedroom furniture)

APPAREL (men's shirts and sweaters, women's dresses, jewelry) 

TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance) 

MEDICAL CARE (prescription drugs and medical supplies, physicians'
services, eyeglasses and eye care, hospital services)

RECREATION (televisions, pets and pet products, sports equipment, admissions); 

EDUCATION AND COMMUNICATION (college tuition, postage, telephone
services, computer software and accessories);

OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and
other personal services, funeral expenses).

Also included within these major groups are various government-charged
user fees, such as water and sewerage charges, auto registration fees,
and vehicle tolls. In addition, the CPI includes taxes (such as sales
and excise taxes) that are directly associated with the prices of
specific goods and services. However, the CPI excludes taxes (such as
income and Social Security taxes) not directly associated with the
purchase of consumer goods and services.

The CPI does not include investment items, such as stocks, bonds, real
estate, and life insurance. (These items relate to savings and not to
day-to-day consumption expenses.)

For each of the more than 200 item categories, using scientific
statistical procedures, the Bureau has chosen samples of several
hundred specific items within selected business establishments
frequented by consumers to represent the thousands of varieties
available in the marketplace. For example, in a given supermarket, the
Bureau may choose a plastic bag of golden delicious apples, U.S. extra
fancy grade, weighing 4.4 pounds to represent the Apples category.


>>New methods of calculating inflation allow "cheating" in compiling
the figures by techniques like "hedonics" which allow ficticious
prices to be calculated for goods to compensate for new features, e.g.
a $300 TV now has picture in picture, it will be claimed the new
feature is worth $200 and therefore the TV is really worth $100, a
price fall, even though a $100 TV is not available to purchase<<

One person's cheating is another person's statistical sophistication.

Oddly enough, the introduction of hedonics came about largely through
criticisms of the CPI as it used to be calculated in the old
non-hedonic days, as a measure that wasn't as good as it should be in
reflecting inflation, since it didn't take into account changes in
consumer goods.

From one month to the next, the overall market basket of goods looks
pretty similar to the month before.  But over the course of years,
consumer goods can undergo great changes.  You mentioned TV as one
example, but I prefer to consider the telephone.  Here's what the
phone looked like when I was growing up:

and here's what it looks like now:

The newer model not only handles phone calls, but can act as a still
camera, video camera, internet hook-up, gaming device, personal
information manager, text messager, and who knows what else!  
Clearly, some sort of accomodation is needed in comparing the price of
Phone A and Phone B over time, and this has come to be known as

I don't know why you refer to this as "cheating", but if you care to
elaborate on your thinking here, I'd be more than happy to discuss it
further with you.

By the way, you also mentioned that the $100 dollar TV is "not
available to purchase"....but isn't it?  Here's one for under $20:

One could certainly use that to argue that the prices for TV's have
come way down over time, rather than increased.  But the problem with
that is, who wants a tiny, black and white TV as their primary
television these days...hence, folks are paying big bucks for large
screen TVs with picture-within-picture features.

>>Guidelines allow for prices of used goods to be substituted for the
prices of new ones if, for some reason, the price increase was "wrong"
for that month<<

I'm not sure what you're referring to here.  If you can provide some
additional details, I'd be glad to look into it for you.

>>Changes in inflation calculation just since the Clinton presidency
alone have reduced reported CPI rates by sevral percent...<<

Again, it would help to have a reference from you for this statement. 
In general, though, it's probably true.  The general thinking among
many (though certainly not all) economists, was that inflation had
been overstated in the past, and that recent adjustments to the CPI
have brought it closer to reality.

Here is a page discussing the Boskin Commission report that critiqued
the CPI in 1995:


...The report highlighted four sources of possible bias:

--Substitution bias occurs because a fixed market basket fails to
reflect the fact that consumers substitute relatively less for more
expensive goods when relative prices change.

--Outlet substitution bias occurs when shifts to lower price outlets
are not properly handled.

--Quality change bias occurs when improvements in the quality of
products, such as greater energy efficiency or less need for repair,
are measured inaccurately or not at all.

--New product bias occurs when new products are not introduced in the
market basket, or included only with a long lag.

and if you really want to dive into the recent changes to CPI, here's
a more in-depth look at the Boskin Report:


The Boskin Commission Report and its Aftermath 

...This paper briefly summarizes the analysis and findings of the 1996
Boskin Commission Report, Toward a More Accurate Measure of the Cost
of Living. It then reviews the comments and criticisms that appeared
soon after the Report was issues and provides responses to the more
important criticisms. Changes in the CPI, both those that were planned
before the Report and those that were in part a response to its
recommendations, are summarized and assessed. The paper concludes with
a summary of recent research on quality change and comments on the
current status of the CPI and of price measurement research.

You can download a copy of the full report here:

>>My questions is: What is the real rate of inflation and how can I track it?<<

For the reasons I laid out above (clearly, I hope), everyone's
experience of inflation is different, and there is no single
unambiguously "true" or "real" measure of the inflation rate.

For fairly typical consumers in the US, the Consumer Price Index is
probably the best measure available for the time being, even with all
it's inherent ambiguities, time lags, and imperfections.

Other measures exist, however, and they can certainly be viewed in
concert with the CPI -- or as a substitute to the CPI -- to get a
picture of inflation from a different angle than that provided by the
CPI itself.

The Wikipedia entry on "Inflation" does an excellent job, I think, of
providing an overview of the main measures of inflation:


...Common measures of inflation include:

--The Cost of Living Index or CLI is the theoretical increase in the
cost of living of an individual, which Consumer Price Indexes are
supposed to approximate. Economists argue over whether a particular
CPI over or under estimates the CLI. This is referred to as "bias"
within the CPI. The CLI may be adjusted for "purchasing power parity"
to reflect the differences in prices for land or other local
commodities which differ widely from world prices. (See Purchasing
Parity Price)

--The consumer price index (CPI) measures the price of a selection of
goods purchased by a "typical consumer". In many industrial nations,
annualised percentage changes in these indexes are the most commonly
reported inflation figure. These measures are often used in wage and
salary negotiations, since employees wish to have (nominal) pay raises
that equal or exceed the rate of increase of the CPI. Sometimes, labor
contracts include cost of living escalators (or adjustments) that
imply nominal pay raises automatically occur due to CPI increases,
usually at a slower rate than actual inflation (and after inflation
has occurred).

--The producer price index (PPIs) which measures the price received by
a producer. This differs from the CPI in that price subsidation,
profits, and taxes may cause the amount received by the producer to
differ from what the consumer paid. There is also typically a delay
between an increase in the PPI and any resulting increase in the CPI.
Many believe that this allows a rough-and-ready prediction of CPI
inflation tomorrow based on PPI inflation today, although the
composition of the indexes varies; one important difference is the
treatment and inclusion of services.

--The wholesale price index which measures the change in price of a
selection of goods at wholesale (i.e., typically prior to sales
taxes). These are very similar to the PPI.

--The commodity price index which measures the change in price of a
selection of commodities. In the case of the gold standard the sole
commodity used was gold. While under the USA bimetallic standard the
index included both gold and silver.

--The GDP deflator which is based on calculations of the gross
domestic product: it is based on the ratio of the total amount of
money spent on GDP (nominal GDP) to the inflation-corrected measure of
GDP (constant-price or "real" GDP). (See real vs. nominal in
economics.) It is the broadest measure of the price level. Deflators
are also calculated for components of GDP such as personal consumption
expenditure. In the United States, the Federal Reserve has shifted
over to using the personal consumption deflator and other deflators
for guiding its anti-inflation policies.

--The personal consumption expenditures price index (PCEPI). In its
semi-annually "Monetary Policy Report to the Congress"
("Humphrey-Hawkins Report") from February 17, 2000 the FOMC said it
was changing its primary measure of inflation from the CPI to the
"chain-type price index for personal consumption expenditures".


Wikipedia also notes that:  "There is no single true measure of
inflation...", a sentiment with which I heartily agree.

Another interesting perspective on Inflation can be found in this
online Encyclopedia of Economics, which starts out with a nice
historical vignette:


Inflation is the loss in purchasing power of a currency unit such as
the dollar, usually expressed as a general rise in the prices of goods
and services. A classic example is the Great Inflation of the Roman
Empire. Successive emperors replaced a steadily increasing fraction of
the silver in their ancient currency, the denarius, with base metals
like bronze or copper. As a result prices rose inexorably despite
repeated attempts to restrain them through legislation. Diocletian,
rather than taking responsibility for the debasement, attributed the
rapid inflation of his day to the avarice of his subjects. His famous
edict of a.d. 301 threatened with death any vendor who charged prices
exceeding official limits. But inflation ran along unhindered for
another century until an alternative currency, an undepreciated gold
coin known to Shakespeare as the bezant, became the customary unit of
account, spreading throughout Europe and lasting well into the Middle

Obviously, a great deal of formal academic, bureaucratic, and
political thought and effort has gone into understanding inflation and
devising measures to track it.

That doesn't mean they got it right!  But it does mean that the
obvious problems with the system have been well-aired, and that no one
has yet arrived at a measure that everyone can agree is a perfect
indicator of inflation.

But I trust the information I presented here gives you the context
needed to better understand why none of the measures in current use
clearly stand out as *the* correct measure of inflation.  I also hope
it is clear why there is not likely to be such a measure in existence
anytime soon.

However, please don't rate this answer until you are fully satisfied
with the results.  If there is anything else I can provide for you,
just post a Request for Clarification, and I'm at your service.



search strategy -- Used bookmarked sites for economics, along with
Google searches on [inflation], [cpi].

Request for Answer Clarification by infoaristo-ga on 18 Nov 2005 13:14 PST
I'm sorry. I think you've failed to grasp what I was getting at with
this question and have not provided what I'm looking for, which was
the actual rate of inflation and a more accurate way of determining
it. You have simply presented an apologist's view of the CPI that I
believe to be wholly innacurate.

Clarification of Answer by pafalafa-ga on 18 Nov 2005 13:36 PST
I'm not an apologist or a defender of the CPI.

But I do firmly believe that there simply isn't such a thing as a
single measure of the "actual rate of inflation", since inflation is
experienced differently by everyone and every organization.  Instead,
there are multiple measures, each with their strengths and weaknesses.

This is what I tried to present in a meaningful way in my answer.

Is it your contention that there should be only one true measure of
inflation that is universally recognized as the actual rate of

If so, perhaps you can provide me just a bit more context about what
you believe and why, and I'll be glad to see if I can provide
additional information that fully meets your needs.

If that doesn't sit well with you for whatever reason, please suggest
an alternative way to go forward.


Subject: Re: The Real Rate of Inflation
From: nancylynn-ga on 18 Nov 2005 17:04 PST
Hello infoaristo-ga:

I spent many hours researching your question. As noted in my Request
For Clarification to you, I did find a few alternate metrics for
measuring inflation, along with research papers and theories that
explore those alternate possibilities. Some of those papers contain
charts comparing metrics.

Just to help clarify for pafalafa-ga: that's what you want: what I
just listed: alternate metrics and alternate theories on how inflation
should be measured?

I certainly agree with pafalafa-ga that there may not be a definitive
best measure. There are certainly a few ardent proponents of some
alternate methods, and methods under consideration by economists, but
I certainly didn't find a widespread consensus on any one alternative
to the CPI, as imperfect as it is.

Google Answers Researcher
Subject: Re: The Real Rate of Inflation
From: myoarin-ga on 18 Nov 2005 18:18 PST
Your scepticism about the validity of CPI as THE measure of inflation,
is something I can understand, as well as your desire to know what
"the real rate of inflation" is.  If it were that simple, there would
be just one calculation of the inflation rate, but there isn't, as
Pafalafa has pointed out.
His "answer" is in the middle of the posting:

>>My questions is: What is the real rate of inflation and how can I track it?<<
For the reasons I laid out above (clearly, I hope), everyone's
experience of inflation is different, and there is no single
unambiguously "true" or "real" measure of the inflation rate.

That is not the answer that you were hoping to have, but that one does
not exist.  I can understand your frustration.  The question is simple
and direct (certainly not simplistic or simple-minded!), but the
answer to it has to address the problem that there just is not one
"unambiguously 'true' and 'real' measure of the inflation rate."

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