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US CPI Falls in April at Fastest Rate since 2008. Even so, could it be Overstating the True Rate of Inflation?

According to data released yesterday by the Bureau of Labor Statistics, the U.S. Consumer Price Index fell in April at an annual rate of -4.35 percent. It was the second consecutive monthly decrease and the fastest rate of decrease since late 2008, when the economy was in free fall.

The April decrease was largely attributable to lower gasoline prices, as have been almost all of the gyrations in the index since the start of the year. The core CPI, which removes its food and energy components, shows much less month-to-month volatility. It rose at an annual rate of 0.6 percent in April, its slowest rate of increase since 2010. The following chart shows that both all-items and core inflation have trended gradually downward over the past two years.

Many people are skeptical of the CPI data published by the BLS. For various reasons, they believe that the true cost of living is rising much faster than the CPI. Given that perceived inflation is generally higher than the CPI indicates, it will come as a surprise to learn that some professional economists think the CPI overstates the rate of inflation, and does so by an increasingly wide margin.

One piece of evidence pointing in that direction is a growing gap between the CPI, calculated by the BLS on the basis of monthly price surveys, and the price index for personal consumption expenditures (PCE index) that is derived from the national income accounts. There are theoretical reasons for thinking that inflation as measured by the CPI, which uses base-period quantity weights, is likely to average a bit higher than the PCE index. (I discussed some of those reasons in this recent post.) The surprising thing, however, is that the gap between the two indexes has been increasing lately, as shown in this figure reproduced from the Atlanta Fed’s Macroblog. (I have added the CPI for April to the original chart.)

Economists Mike Bryan, Pat Higgins, Brent Meyer, and Nicholas Parker of the Atlanta Fed undertook some statistical analysis to see if the increasing gap between the two indexes is real, or just an artifact of the data. Their conclusion is that there really is a gap, although perhaps the underlying gap is not quite as wide as that shown in the above chart.

As they suggest, the possibility that the CPI is overstating inflation can be viewed as a glass that is either half-full or one that is half-empty. Pessimists may take a very low rate of PCE inflation as a sign that the Fed is failing in its efforts to meet its price stability mandate, which it defines as a 2 percent inflation rate for the PCE. Personally, I prefer to take a more optimistic view. Right now the economy is making at least gradual progress back toward full employment, at a time when Europe and Japan are struggling with much worse problems and emerging market growth is slowing. It would be a shame to see that progress derailed by a burst of inflation that frightened policy makers into tightening while the recovery remains so fragile. None of the inflation indicators we are seeing right now suggest any such risk.

For more inflation charts, see this slideshow.

8 Responses to “US CPI Falls in April at Fastest Rate since 2008. Even so, could it be Overstating the True Rate of Inflation?”

JohnMay 18th, 2013 at 2:06 am

Your mother's washing machine lasted 25yrs. The first washer you bought made it for 15yrs. Five years ago the same washer was good for 10yrs and today you would be doing well to get 6-8 yrs out of it. This is called inflation because it takes 2-3x as much money to keep your clothes clean.

I work in a major home improvement center and have sold about 5,000 of these appliances and have seen the same trend among almost all categories of goods and serivces.

EdDolanMay 18th, 2013 at 10:21 am

At the same time, tires last longer, cars last longer (average age of cars on US roads is at a record), computers last longer (each laptop I have bought over the past 20 years has lasted longer than the previous one). You should also note that your new washing machines use less hot water and your refrigerators use far less electricity.

Lesson: Quality changes cut both ways. Most observers believe that on average quality of goods is improving despite exceptions.

JohnMay 19th, 2013 at 2:36 am

The savings on hot water and electricity is the great charade. It is very unlikely that it will offset the $400 you will spend on an electronic circuit board (and other repairs) within your first 5 yrs of owning a new major appliance. As for automobiles the cost of parts and labor to maintain them is high.

Lesson: Quality does cut both ways. But the "man on the street" will tell you that most of what is being manufactured in Asia (particularly China) is junk.

EdDolanMay 19th, 2013 at 10:27 am

The popular idea that "most of what is being manufactured in Asia (particularly China) is junk" is a very old one. I remember a popular urban myth when I was a kid in the 50s was that if you took apart a made-in-Japan toy, you would find the label of a Budweiser can that was thrown away by some GI, then salvaged to make the toy. There was never anything on the inside of my toys if I peeked, though.

More seriously, objective studies like the annual J.D. Power Vehicle Dependability ratings give high marks to Asian products. For example, their 2013 report of the top-10 gives places 1-7 to Japanese cars and the highest US car is No. 8.

What I am getting at is this: Is there any objective evidence to back up your study, or are you just doing anecdotes. I understand you are in the appliance business, so it would be perfectly natural if you frequently encountered customers who brought back defective products for repair, but never heard again from customers who had good experience with their products. That would mean you are working with a biased sample.

In short: I am rarely willing to believe the "man on the street" without data to back it up, because so often, when the data is available, it turns out the man on the street is extrapolating from rumor or atypical anecdotal evidence. For example, the streets are full of men and women who believe that cell phones and wi-fi give you brain cancer, but it is hard to find data to back it up.

EdDolanMay 20th, 2013 at 10:36 am

I agree many who source to China for price alone get low quality. However, some companies like Apple get quality work out of China. You get what you pay for anywhere.

Gary AlexanderMay 21st, 2013 at 2:04 pm

Prices don't rise or fall equally, of course, but when monetary inflation is sustained for so long, and in such volume, the liquidity usually goes somewhere. Is it possible that Fed liquidity rescued the moribund housing market and accelerated the stock market boom? Also, due to the widening wealth gap, the cost of luxury items is soaring. A lunch with Tim Cook of Apple just auctioned at $610,000 (expected value: $50,000) and paintings are once again drawing 8-figure prices at auction. CPI and PPI seem muted since they reflect prices the 99% pay, but the new money must go somewhere, right? Stocks, yachts and paintings?

EdDolanMay 21st, 2013 at 7:51 pm

Absolutely. The idea that monetary expansion, coupled with stability of broad price indexes, can lead to asset bubbles and, potentially, to malinvestment and future crises was at the heart of Hayek's theories way back in the 1930s. Some people see definite parallels between today's stock market boom and that of the 1920s, which also took place against a background of broad price stability.

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