Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
US Housing Market Real Terms BUY / SELL Indicator - 16th July 19
Could Trump Really Win the 2020 US Presidential Election? - 16th July 19
Gold Stocks Forming Bullish Consolidation - 16th July 19
Will Fed Easing Turn Out Like 1995 or 2007? - 16th July 19
Red Rock Entertainment Investments: Around the world in a day with Supreme Jets - 16th July 19
Silver Has Already Gone from Weak to Strong Hands - 15th July 19
Top Equity Mutual Funds That Offer Best Returns - 15th July 19
Gold’s Breakout And The US Dollar - 15th July 19
Financial Markets, Iran, U.S. Global Hegemony - 15th July 19
U.S Bond Yields Point to a 40% Rise in SPX - 15th July 19
Corporate Earnings may Surprise the Stock Market – Watch Out! - 15th July 19
Stock Market Interest Rate Cut Prevails - 15th July 19
Dow Stock Market Trend Forecast Current State July 2019 Video - 15th July 19
Why Summer is the Best Time to be in the Entertainment Industry - 15th July 19
Mid-August Is A Critical Turning Point For US Stocks - 14th July 19
Fed’s Recessionary Indicators and Gold - 14th July 19
The Problem with Keynesian Economics - 14th July 19
Stocks Market Investors Worried About the Fed? Don't Be -- Here's Why - 13th July 19
Could Gold Launch Into A Parabolic Upside Rally? - 13th July 19
Stock Market SPX and Dow in BREAKOUT but this is the worrying part - 13th July 19
Key Stage 2 SATS Tests Results Grades and Scores GDS, EXS, WTS Explained - 13th July 19
INTEL Stock Investing in Qubits and AI Neural Network Processors - Video - 12th July 19
Gold Price Selloff Risk High - 12th July 19
State of the US Economy as Laffer Gets Laughable - 12th July 19
Dow Stock Market Trend Forecast Current State - 12th July 19
Stock Market Major Index Top In 3 to 5 Weeks? - 11th July 19
Platinum Price vs Gold Price - 11th July 19
What This Centi-Billionaire Fashion Magnate Can Teach You About Investing - 11th July 19
Stock Market Fundamentals are Weakening: 3000 on SPX Means Nothing - 11th July 19
This Tobacco Stock Is a Big Winner from E-Cigarette Bans - 11th July 19
Investing in Life Extending Pharma Stocks - 11th July 19
How to Pay for It All: An Option the Presidential Candidates Missed - 11th July 19
Mining Stocks Flash Powerful Signal for Gold and Silver Markets - 11th July 19
5 Surefire Ways to Get More Viewers for Your Video Series - 11th July 19
Gold Price Gann Angle Update - 10th July 19
Crude Oil Prices and the 2019 Hurricane Season - 10th July 19
Can Gold Recover from Friday’s Strong Payrolls Hit? - 10th July 19
Netflix’s Worst Nightmare Has Come True - 10th July 19
LIMITLESS - Improving Cognitive Function and Fighting Brain Ageing Right Now! - 10th July 19
US Dollar Strength Will Drive Markets Higher - 10th July 19
Government-Pumped Student Loan Bubble Sets Up Next Financial Crisis - 10th July 19
Stock Market SPX 3000 Dream is Pushed Away: Pullback of 5-10% is Coming - 10th July 19
July 2019 GBPUSD Market Update and Outlook - 10th July 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

The Many Failures of the CPI Consumer Price Index

Economics / Inflation Apr 30, 2015 - 04:31 PM GMT

By: Mark_Thornton

Economics

Austrians oppose the whole notion of trying to accurately measure “inflation” which mainstream economists see as a general rise in prices. (Austrians view inflation as a politically engineered increase in the money supply.)

A few years ago, mainstream economists like Paul Krugman chastised the Austrians for the lack of anticipated price inflation in the economy. However, their mistake was a fixation on the Consumer Price Index (CPI). If you looked around at other prices in the economy you could see higher prices in just about every other market, such as commodities, oil, gold, producer goods, real estate, and stocks.


More recently, mainstream economists have returned to fears about there not being enough inflation, and their outsized fear of deflation. For them, their fear justifies Zero Interest Rate Policy (ZIRP) and Quantitative Easing (QE), but they fail to explain why we must have rising prices. When it comes to the cost of living, most people prefer falling prices to rising prices, a condition that typically characterizes a true free market economy.

The Futility of Price-Inflation Measurements

The practical problems with price indexes such as the CPI are the issues of which prices are to be measured and what “weights” will be assigned to what goods. Another problem is deciding what to do about changes in quality. For example, what do you do when Apple introduces a new and improved iPhone at the same price as the previous version?

To deal with this, government statisticians systematically increase the weights for goods that are going down in price and reduce the weights of things are going up in price. If the quality of a good goes up, the statisticians “hedonically” reduce the price of the good.

Those sorts of adjustments do not seem fair to most normal people. If you are eating more ramen noodles and fewer lamb chops you can take little comfort in the fact that that the CPI is staying inside the Fed’s target range. Moreover, under the system of hedonic adjustments, every time entrepreneurs and engineers come up with better products for consumers at lower prices, the Fed takes credit for keeping inflation under control.

A Debate Over Alternative Measures

One economist that takes exception to these adjustments is John Williams, owner of ShadawStats.com. Williams offers alternative measures of government statistics based on older methodologies where the goods, weightings, and quality adjustments play less of a role. His measure of CPI, for example, shows price inflation much higher than government statistics. Whether Williams’s calculations are more accurate than the government statistics is hard to say, however, because both are constructed on the same inherently flawed foundations.

One recent critique of Williams’s statistics comes from Ed Dolan. He criticizes Williams not for his belief that CPI understates the impact of the Fed on the cost of living, but for the way he calculates his alternative measure:

No one really denies that the CPI, as presently calculated, understates the rate of inflation compared to a measure based on a fixed basket of unchanged goods. Rather, what many economists, myself included, find hard to accept is Williams’s estimate of the degree of understatement.

This friendly dispute does not solve the problems of calculating the cost of living or price inflation, but only serves to underscore the futility of such an undertaking, a point first established by Ludwig von Mises.

Furthermore, the whole discussion obscures the real impact of the central bank’s “monetary policy.” In the absence of a central bank, it is generally assumed that the supply of money would grow slowly because real resources have to be expended to create gold and/or silver (or anything else, including Bitcoin) to serve as the monetary base.

In an expanding market economy, improvements in technology, efficiency, and productivity means that you would experience real economic growth per capita of at least 2–4 percent per year. If the supply of money is increasing slower than production, then the economy will experience price deflation and a stronger currency.

What Would the CPI Be With a Fixed Money Supply?

The full impact of the central bank’s monetary policy is better described by adding consumer price inflation (higher prices) and the foregone price deflation together. The combined amount shows a truer picture of the negative impact the Fed’s monetary policy has on the typical wage or salary earner. Economist Mark Brandly provides an estimate of this damage to an economy that consists largely of workers on fixed wages.

He calculates what the CPI would have been between 1959 and 2005 if the money supply had been fixed. Using data on the actual money supply and actual CPI, he calculates that the actual CPI in 2005 was 6.7 times higher than the CPI in 1959. In the absence of increases in the money supply, however, he calculates that CPI would have fallen by 80 percent so that the actual CPI was thirty-four times larger than what the CPI would have been in the absence of the Fed.

What would this mean for the common man? Brandly provides a few estimates about what this world would look like in terms of the prices of goods the consumer would face today:

Let’s put this in everyday terms. Suppose these estimates represent the changes in the prices of goods such as hamburgers, cars, and housing. According to these numbers, a hamburger that cost 60¢ in 1959 would have cost $4 in 2005. If the money supply had been fixed, however, that hamburger would only cost 12¢ today. Similarly, a $20,000 car in 2005 would have cost slightly less than $3,000 in 1959. Again, without the monetary effect on prices, that car would only cost $600 today. The price of a $45,000 house in 1959 would have increased to $300,000 in 2005. With a fixed money supply, that house would cost $9,000 today.

Ultimately, however, “fixing” the CPI would accomplish little. The Fed would continue to do significant harm to the working class and enrich the wealthy and the political class. The Fed has destroyed the incentive to save and turned financial markets into crony casinos. Meanwhile, economic inequality is the worst in American history. The Fed has blown up enormous economic bubbles and they are stuck with seven years of ZIRP and are too afraid to change course for fear of blowing up the world economy. Tinkering with the CPI won’t solve these problems.

Mark Thornton is a senior resident fellow at the Ludwig von Mises Institute in Auburn, Alabama, and is the Book Review Editor for the Quarterly Journal of Austrian Economics. He is the author of The Economics of Prohibition and co-author of Tariffs, Blockades, and Inflation: The Economics of the Civil War. Send him mail. See Mark Thornton's article archives. Comment on the blog.

© 2015 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules