For years the Federal Reserve and many other central banks around the world have declared that a key element of monetary policy is targeting the annual price inflation. Now the Federal Reserve has suggested that that target rate may be “temporarily” raised to – well, they have been less precise about that.

As measured by the Consumer Price Index (CPI), prices in general have been increasing for most of the last ten years at well below two percent. Even “core” price inflation – that is, the CPI minus energy and food prices – has been below the two percent target rate for most of this time.

The price index is a false guide for monetary policy.

 

price deflation Price Inflation CPI
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But in February 2017, the overall CPI increased at a 2.7 percent annual rate, and the “core” CPI, was 2.2 percent higher. Even the alternative index that Fed Chair, Janet Yellen, and other Fed Board Governors prefer to watch, Personal Consumption Expenditures, was up to almost two percent, in February, as well.

It is worth observing that, even if average CPI price inflation were to be kept at a rate of two percent a year, in less than twenty years, the value of the dollar will have decreased by about 50 percent. That is, the buying power of today’s CPI-measured dollar would only get you an equivalent of 50 cents worth of similar goods in less than two decades.

More fundamentally, any price index, whether the CPI or the PCE, is a statistical construction created by economists and statisticians that has very little to do with the actions and decisions of consumers and producers in the everyday affairs of market demand and supply. The price index is a false guide for central bank monetary policy.

Constructing CPI

In constructing the CPI, the Bureau of Labor Statistics (BLS) surveys the purchases of 7,000 households across the country, which are taken as a representative of the approximately 325 million people living in the United States. The statisticians then construct a “basket” of goods, reflecting the relative amounts of consumer items that the surveyed households regularly purchased. Every month, the BLS records the prices changes of these goods, sold in 24,000 retail outlets, which stand in for the estimated 3.6 million retail establishments across the country.

This is, then, taken to be a fair and reasonable estimate o the cost of living and the rate of price inflation for all the people of the United States. Due to the costs of doing detailed consumer surveys and the desire to have an unchanging benchmark for comparison, this consumer basket of goods is only significantly revised about every ten years or so.

There is no “average” American family. Tastes and buying patterns are as diverse as the 325 million people who live in the United States.

 

Over the intervening time, they must assume that consumers continue to buy the same goods and in the same relative amounts, even though in the real world, goods come and go from the marketplace, quality sometimes improves, and the price changes result in people modifying their relative buying patterns.

In measuring inflation, the government’s CPI statisticians distinguish between two numbers: the change in the overall CPI and “core” inflation. They make this distinction because they argue that food and energy prices are more “volatile” than many others. Fluctuating more frequently and to a greater degree than most other commonly purchased goods and services, they can create a distorted view, it is said, about the magnitude of price inflation during any time.

The problem is that food and energy costs may seem like irritating extraneous “noise” to the government number crunchers, but to the rest of us, what we pay to heat our homes and put gas in our cars, as well as buy groceries to feed our families, is far from being a bothersome distraction to the statistical problem of calculating price inflation’s impact on our everyday lives.

The fact is, there is no “average” American family. The individuals in each household all have their own unique tastes and preferences. This means that your household’s basket of goods is different in various ways from mine, and our respective baskets are different from everyone else’s. Tastes, circumstances, and buying patterns are as diverse as the 325 million people who live in the United States.

Looking Inside the Consumer Price Index

This means that when there is price inflation (or deflation) those rising (or falling) prices impact each of us differently. Let’s look at a more detailed breakdown of some of the different price categories hidden beneath the CPI’s aggregate of prices as a whole.

In the twelve-month period ending in February 2017, food prices as a whole in the CPI rose zero percent, a seemingly stable price environment for food shopping. However, according to the BLS, many food prices decreased over the previous 12-month period.

For example, meat, poultry, fish, and egg prices decreased by 3.3 percent altogether. But when we break this aggregate down, we find that beef and veal prices declined by 4.4 percent, frankfurters decreased 5.3 percent, lamb and mutton decreased by 7.0 percent, and chicken prices declined by 3.3 percent. However, fresh fish and seafood prices were 5.5 percent higher than a year earlier.

The prices of these goods and services, in the combinations that we as individuals choose, are what we experience as our personal rate of price inflation.

The fact that lamb prices declined over fifty percent more than the price of chicken, might lead some meat eaters to purchase and eat more lamb versus chicken since the relative price of one had fallen significantly in terms of the other.

Under the general energy commodity heading, prices went up overall by 15.2 percent overall; but the price of propane increased by 8.8 percent over the twelve-month period, while electricity prices, on the other hand, increased by only 1.9 percent. But gasoline for our cars was up by a huge 30.6 percent, and utility (piped) gas rose by 10.9 percent over the last year.

Meanwhile, furniture and bedding prices decreased by 1.4 percent, and major appliances that declined in price by 4.6 percent. New televisions prices dropped a significant 20.1 percent over the year. At the same time, men’s apparel went up 2.2 percent while women’s dresses rose by 5.4 percent.

Medical care services, in general, rose by 3.4 percent, but inpatient and outpatient hospital services increased, respectively, by 3.9 percent and 4.3 percent. Prescription drug prices rose, on average, by 5.2 percent and physicians’ services increased by 3.6 percent between February 2016 and February 2017.

Individual Prices Influence Choices, Not the CPI

The pricing subcategories highlight the smoke and mirrors that is the statisticians’ distinction between overall and “core” inflation. People will occasionally enter the market to purchase a new stove, couch, or bedroom set, and if the prices for these goods happen to be going down, or slowly rising, we may sense that our dollar is going further than in the past.

Factors of production and the relevant pricing of finished goods influence the choices of consumers and the decisions of entrepreneurs.

 

But buying goods like these is an

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