The Inflation Rate in 2011 Was 7.2% - Depending How You Measure It!

I am becoming a real fan of the American Institute of Economic Research site.  

Don't know about you, but I often think (worry) about the inflation rate.  The Fed has juiced the money supply numbers quite a bit since 2008.  Something like a 48% increase since the start of the crisis in 2008.  If the money supply increases by that much in 4 years and there is no associated increase in production then where is the inflation, ya' know, "too much money chasing too few goods".  Correct?  Furthermore, I understand that this is somewhat mitigated by banks sitting on the excess funds to bolster their loan loss reserves against anticipated losses.  Obviously, the subject of a future post.  But, my wife and I keep noticing that when we go to the grocery store things cost more.  Filling up the car is seldom a joyous experience and the utility bill, although seasonal, is not going down.  

The AIER article below is interesting because they showcase their own EPI inflation index and compare it to CPI of the BLS.  The EPI, Everyday Price Index, is different from the CPI because it measures what ordinary people are exposed to on a daily basis.  Something I always thought was lacking in the CPI.

The article is in italics and the bold text is something I added.  The charts/graphs are at the bottom.  Good charts!!!!  Check out the website.  AIER

Most Americans in 2011 experienced a day-to-day inflation rate of 7.2 percent—more than two times the official estimate released by the Bureau of Labor Statistics.  This preliminary finding based on a price index with static weights comes from the Everyday Price Index (EPI). AIER developed the new proprietary index to measure the actual price experience of ordinary people.

The most widely quoted official estimate, the Consumer Price Index (CPI), puts the 2011 inflation rate at 3.1 percent. That’s because the CPI uses a different array of goods and services to calculate the average annual percentage change in the cost of living.

The Everyday Price Index includes only the prices of goods and services that the average consumer purchases at least once a month.

The index includes food and beverages, household energy products and services, other utilities, motor fuel, prescription drugs, child care fees, phone services, personal care products, and other goods and services purchased on a regular basis. 

Unlike the CPI, the Everyday Price Index does not include housing. Despite the housing debacle caused in part by variable rate mortgages, most people do not renegotiate rent or mortgage payments on a regular basis. In addition, the index ignores big-ticket items such as household appliances and furnishings and new and used cars. It also excludes less expensive but irregularly purchased goods such as apparel and information technology.

The frequently purchased products in the Everyday Price Index make up only about 39 percent of total household spending. But changes in the prices of these products are what people experience day to day. They account for sticker shock at the pump and at the supermarket check-out, and they impact month-to-month household budgets in a way that fixed costs do not.

Chart 1, below, shows the long-term implications of the difference between the CPI and the Everyday Price Index. We set the index values for both the CPI and EPI to 100 for January 2000. In December 2011, the CPI was 133.69 and the EPI was 156.89. This means since 2000, the CPI increased by about 34 percent, while the EPI increased almost twice as fast, by about 57 percent.

Interpreting the implied difference in purchasing power involves thinking separately about day-to-day experience and the broader long-term cost of living. Over the course of a year, the price of a hamburger or a pound of coffee may change dramatically. But a car payment cannot because it is contractually fixed. In addition, certain intermittently purchased goods such as televisions and computers are falling in price (especially on a quality-adjusted basis). Coffee and hamburgers tend to put upward pressure on the broader cost of living. Cars, televisions, and computers tend to exert a downward pressure.

According to the BLS, the average price of an automobile rose 2.4 percent from January 2000 to December 2011, substantially less than the change in the CPI. This means that a car that cost $25,000 at the beginning of the decade now costs $25,600. That number probably seems low because the price has been adjusted for quality: New cars in 2011 have many features that cars in 2000 did not have. But because buyers often do not have the option to buy a car without the new features, they pay substantially more in actual dollars than the value suggested by the CPI.

If the inflation rate of big-ticket items such as cars matched that of everyday items, consumers would be appalled. If the price of cars matched the CPI’s overall inflation rates without quality adjustment, for example, a car that cost $25,000 in 2000 would be $33,423 today. If the price of cars matched day-to-day experiences (EPI), then that same car would cost $39,222.

Buying a car is a much bigger hit to one’s wallet than day-to-day outlays for food, fuel, and other simple necessities. Therefore, big purchases have a larger impact on the overall cost of living. In the CPI, the lower inflation rate for cars (and similar items) offsets a substantial part of the increases in other prices. The everyday inflation rate that people experience is moderated to some degree by quality adjustment and slower growth in the prices of infrequently purchased goods and services.

The Everyday Price Index is also more volatile than the CPI, as Chart 2 shows. The chart compares annual increases (monthly year-to-year changes) in inflation since 2000 according to the two indexes. There are striking differences.

While the CPI stayed relatively stable in the 4 to 5.5 percent range in mid-2008, the EPI peaked at 12.4 percent in July of that year. The EPI also indicates a broad deflationary period from November 2008 through October 2009, which peaked at -9.9 percent. This was probably led by declines in energy prices, and helps explain the Fed’s nearly panicked attempts to expand the money supply during that period.

More recently, EPI inflation hit 8.9 percent in May 2011 and was as high as 6.2 percent in November. For the latest month, EPI inflation is 4.5 percent versus CPI inflation of 2.9 percent.

The government is not cooking its numbers. The official CPI is not designed to measure the everyday experience of people. Rather, it is supposed to be a policy guide that reflects broad changes in consumer price levels. The faster increase in prices of the frequently purchased items measured by the Everyday Price Index may explain why some people feel that the official CPI numbers are at odds with their own perceptions of inflation.

The CPI is still the best way to measure broad-based inflation. As measured by the CPI, inflation has been relatively contained since 2009, in part because of the financial crisis and the recession. Now that seems to be changing. The average CPI inflation for 2011 of 3.1 percent is almost double the 2010 inflation rate of 1.6 percent. The rate also tracks with the 30-year average CPI inflation rate of about 3 percent per year.

Given the monetary expansion policies pursued by the Federal Reserve in the last few years, inflation is unlikely to moderate and may even accelerate in the future. The Fed increased M1, the narrowly defined money supply that consists of currency and demand deposits only, by 14 percent in 2011 alone and by 48 percent since the start of the financial crisis in 2008.

Historically, such a large expansion of the money supply has always resulted in higher inflation. For now, most of the additional money created by the Fed is accumulating in the excess reserves held by banks. But recently banks have started lending again. Reserves have started flowing out of the banks and into the wider economy through a somewhat increased volume of consumer loans and a more dramatic increase in the volume of commercial and industrial loans. There are also some early signs of life in the housing market and therefore in mortgage-loan origination.

All forms of lending convert bank reserves into money, available to be spent by consumers on goods and services. If the money enters the economy without a corresponding increase in output, higher inflation will follow. With money supply increases in the 14 percent range and output increases forecast in the 2 to 2.5 percent range, it seems likely that the money supply will outpace output.

Chronic price inflation—even at moderate rates—leads to significant losses of buying power over time, a fact often obscured by the general focus on comparatively small monthly or annual price changes. During the past decade, the average rate of price inflation measured by the Consumer Price Index was 2.4 percent. Most people accept a 2.4 percent inflation rate as fairly tame. Yet it implies a loss of more than one-fifth of the purchasing power of the dollar over the decade.

Inflation does not affect all goods and services in the same way. A breakdown of the CPI into broad categories of goods and services in Chart 3 shows where price pressures have been the greatest during the past three decades. The price indexes for higher education and medical care have increased considerably faster than the overall price level. Prices for items such as clothing and cars have increased at a slower pace.

The table at below (Chart 3) provides BLS data on the detailed breakdown of the cumulative changes in the prices of goods and services from the beginning of 2000 through the end of 2011. An eclectic mix of commodities and services registered the greatest percentage growth in prices. Not surprisingly, gasoline and other energy products showed the most price appreciation. But tobacco, educational and medical care services, poultry, eggs, beef, and utilities services also posted big gains.

At the other extreme, the prices of (constant quality) televisions, personal computers, and other information-processing equipment have plummeted, primarily because of improvements in quality and features.

Because prices of different goods and services change at different rates, each household has its own price index—its own cost of living. Households that purchased relatively more of the items near the top of the table suffered a larger increase in their cost of living than implied by the increase in the aggregate CPI. Those that spent more on the items shown near the bottom of the list experienced a relatively smaller increase.