Understanding CPI

Economics Economics Questions
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1

I’m not an economist or an economy student, but I do have an interest in this stuff and I am struggling to understand CPI. I’m not sure if it is really all that important to understand fully. Perhaps someone can offer me some advice or clarification.

I watched this video:

http://www.youtube.com/watch?v=zPkTItOXuN0

Then read this:

http://www.bls.gov/opub/mlr/2008/08/art1full.pdf

And this:

https://forum.freecapitalists.org/blogs/alexmerced/archive/2010/08/12/the-federal-reserve-price-stability-and-cpi.aspx

And now I just feel confused. Is CPI even a relevant/important number to understand? The idea that hotdogs are substituted for salmon or ground beef for steak seems to be a mis-characterization, at least according to the PDF. To me, this is just one persons’ word against the other’s. Does BLS actually publish the data they use to calculate this stuff and what adjustments they make or is it all done in the dark?

Any input will be greatly appreciated!

2

The Consumer Price Index (CPI) is defined by the U.S. Bureau of Labor Statistics as a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The CPI is a poor inflation measurement. Austrian economist William L. Anderson said, "the CPI can perpetuate the myth of “cost-push” inflation, in which the cause of rising prices is, well, rising prices. Indeed, many evening news broadcasts on the new CPI figures will begin with something like, “Increases in gasoline prices have helped ignite a new round of inflation, the Labor Department reported today.”

Furthermore, the portrayal of the “official” version of inflation as an average causes other mischief as well, the most noticeable being the classification of the prices of some goods and services as “rising faster than the rate of inflation.” The implication of such a statement is that if the price of something increases at a faster rate than the increase in the CPI, then something illegitimate must be occurring. Soon afterward, politicians begin to call for price controls, and then the real damage to the economy begins.

As economists and others of the Austrian School understand, inflation occurs when the value of money declines relative to the goods and services it can purchase. In other words, inflation is a monetary phenomenon, not a price phenomenon. Prices go up because inflation is happening, not the other way around.

During a period of inflation, prices of some things increase more rapidly than prices of others. For example, during the last decade, money prices of gasoline and food have increased, while personal computer prices have fallen. That does not mean computers are impervious to inflation, but rather that inflation affects different items in different ways. Furthermore, without inflation, computer prices would have fallen even further.

What, then, is the real rate of inflation if the CPI is inaccurate? The truth is that there is no good way to gain a true measure of inflation, especially in this era when the Federal Reserve System is flooding the economy with new dollars. All we can say for certain is that inflation, with all its evils and distortions, has become what seems to be a permanent part of our economy."

Although the CPI is a poor measurement for inflation, even it shows massive dollar devaluation. $1 in 1913 has the same buying power as $22.09 in 2010, according to the Bureau of Labor Statistics’ CPI inflation calculator.

3

Thanks for that answer, it is very helpful.

What I take away from it is that CPI isn’t that useful, but that even so it shows massive devaluation of the dollar.

“CPI is defined by the U.S. Bureau of Labor Statistics as a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”

BLS’s own definition is wrong since it isn’t that.

Substitution means it isn’t measuring the same basket of goods over time (even if it isn’t substituting hamburger for steak it could easily be changing the quality of the food item being substituted).

4

The Austrian definition of inflation is different from those who use the CPI. To Austrians, Inflation is an increase in the amount of money and/or credit. The CPI is an attempt to measure the increase in prices resulting from previous inflation/s.

So even if government did not manipulate the CPI to say things it likes, the CPI and all other price indicies would not measure inflation.

If you want a good inflation measurement then the True Money Supply is probably best. The price of gold relative to a fiat currency is another good one.

5

This is patently untrue. You are giving the Rothbardian definition, which no pre-Rothbard Austrian (ergo true Austrian) would support.

Mises, Hayek, Schumpeter, and every non-Rothbardian modern Austrian, like White, Selgin, and Horwitz, for example, all agree that inflation is actually an increase in the amount of money with regard to demand. If demand increases, but the money supply does not, then you have deflation. This is why Mises appears to state at one point that deflation, while disruptive, isn’t as harmful as inflation: He is talking about the deflation caused by demand increasing faster than money supply.

Note that money supply increases under a gold standard, generally at a rate of about two percent per year.

It’s become common to refer to “price inflation” in order to clarify, when talking on a context where the inflation of money supply may be confused for that.

The CPI is not attempting to measure the increase in prices resulting from previous inflation of the money supply…but an attempt to measure any global trend of increasing prices, regardless of the cause.

That is a terrible measure of EITHER form of inflation, as it ignores the changes in demand for money, ergo doesn’t measure actual inflation/deflation, and of course does not measure global price changes driven by any shift in said balance of the supply/demand ratio for money, either.

No, that’s even worse…in fact, meaningless. Gold’s price in any one currency, and its overall value, fluctuate wildly, based on supply, demand, and (because of our government-imposed commodity markets) speculation.

That the price of gold in dollars increased 700% in ten years, while the money supply did not even double, illustrates the fallacy of that comparison.

Look at the image used as a group logo for

, going back centuries. I’ll try find the original image and link to the data, when I get home.

6

It’s not a myth that prices CAN rise on their own, even globally, and you cited a perfect example of that.

Obviously, if energy prices shoot up, the cost of producing everything made with energy (hint: everything) is going to face a pressure to increase in price, as well. This is one of the problems of the past decade.

It is purely a Rothbardian myth, that prices CANNOT increase for reasons other than inflation of the money supply. It’s also patently absurd on its face, as any real Austrian would acknowledge.

The problem with the CPI is that it does not address real prices of any sort…it cannot track global price inflation OR deflation, because of taking the basket approach. In fact, it conceals deflation or prices even worse than inflation…for example, if the prices of existing consumer goods are dropping because of new models coming out that contain new features, the basket approach will incorporate those new-featured models, creating the illusion that prices are rising, when they are actually falling.

The CPI, and other attempts to measure prices in a global sense, are only guesses…but they are more useful than having no guesses at all. The tendency of the Rothbardians to try to dismiss them (except when they appear to confirm Rothbardian dogma) is also patently silly.

7

This is absolutely incorrect and it shows a profound misunderstanding of basic economic doctrine. Prices don’t just magically rise on their own (nothing just magically happens on its own). Milton Friedman, who’s not a Rothbardian, was correct when he proclaimed that ‘inflation is always and everywhere a monetary phenomenon.’ In a state where the supply of money and total output are invariable, any increase in the price of an economic good is met with a corresponding diminution in the price of another economic good (or a corresponding diminution in the price of multiple economic goods), so that the total price level cannot change.

The cost-push theory of inflation is pure economic quackery, a remnant of classical economics, where value was objectively determined either by the cost of labor, or the cost of production in general. Rising costs means lower profit margins which, in turn, will lead to a reallocation of capital and the original means of production away from certain industries (left-ward shift in supply) towards others, which will equalize profit margins (towards the natural rate) across the board. The cost of production plays no role in the determination of long-run prices, which are entirely subjectively determined.

The problem of the last few decades is continuous inflation and arbitrarily suppressed market interest rates (below the natural rate). In other words, the biggest problem of the last few decades has been central banking.

8

Are you actually suggesting that costs play a roll in the determination of short-run prices? We’re talking about actual [meaningful] market prices as determined during exchange. Not some wishful sticker prices people attach to their unsold inventories.

9

This is absolutely incorrect and it shows a profound misunderstanding of basic economic doctrine. Prices don’t just magically rise on their own (nothing just magically happens on its own). Milton Friedman, who’s not a Rothbardian, was correct when he proclaimed that ‘inflation is always and everywhere a monetary phenomenon.’

Yes, because he agreed with what I was saying, that you did not fully quote.

As I already said, INFLATION is always a monetary phenomenon. But some people are so ignorant of economics that they don’t realize prices can increase WITHOUT it being inflation.

I reiterate my example:

Oil prices increase 700%, because of an increase in demand, a decrease in relative supply, and speculation based on the strife between the US and four different regions of the world vital to oil supply.

This drives up prices on ALL goods, since all goods require energy and oil is the biggest source of energy.

This is a global increase in prices. It is NOT “inflation”, because it is not driven by money.

In a state where the supply of money and total output are invariable, any increase in the price of an economic good is met with a corresponding diminution in the price of another economic good (or a corresponding diminution in the price of multiple economic goods), so that the total price level cannot change.

This does cater to Rothbard’s ignorance of monetary theory, but ignores the actual monetary theory of real Austrians. When demand for money increases, money supply SHOULD increase, or else you get the kind of crisis we suffered recently in the US. This doesn’t make the overall price increase monetary, it just means that the money supply responded to demand…the way Mises, Hayek, Schumpeter, Friedman, Selgin…pretty much everyone but the Rothbardians…acknowledges it should.

10

Where do people get the money to pay for ‘all’ these price rices? That’s simply impossible. Some prices have to go down.

Do you claim you can quote Mises/Hayek to back this theory up? If so: please do.

11

This is wrong. Again: if ‘oil’ becomes more expensive, than other things go down. There just isn’t enough money to pay ‘all’ of the price raises.