YOU DECIDE: Is the true inflation rate being hidden?

Date posted: July 6, 2012

Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.

Media Contact: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

By Dr. Mike Walden
North Carolina Cooperative Extension

One of the most frequent questions I’m asked in my presentations across the state is about inflation. Specifically, people want to know if the true inflation rate — aka the rise in the cost of living — is being hidden.

The skepticism about the reported inflation rate revolves around three questions. Does it include everything we typically buy or are some important products omitted? Does it match everyone’s personal experience? And why does it often seem prices are rising faster than what the official inflation rate suggests? Let me try to address each of these questions.

At just about every one of my meetings, I can count on someone saying the official inflation rate is useless because it excludes prices of two of our most important necessities, food and fuel. And the individual will continue, because in many months the prices of food and fuel are rising faster than other prices, the result is an inflation rate that is lower than what most of us experience.

So what about this charge? It is true the government reports an inflation rate that omits food and fuel prices. It’s called the core inflation rate. But it’s also true the government releases in the same report an inflation rate that includes food and fuel prices. This measure is typically referred to as the headline inflation rate.

Why does the government report two inflation rates, the headline rate and the core rate? The reason is that each rate has its own advantages and disadvantages and therefore gives different information to different audiences.

The headline rate includes prices of everything we buy, and this is its major advantage. So if you want to see how consumer prices moved last month, the headline rate gives the answer.

But the downside of the headline rate is it can be moved by price changes that are temporary. For example, if there’s a hurricane that destroys some crops or knocks out gas refineries for a period, food and fuel prices could jump in one month only to be followed by price declines the next month. Watching the headline rate in either of these months would give a distorted view of the long-run trends in prices.

This is why the core inflation rate is also calculated and reported. It gives the inflation rate for all consumer products and services except those that are most subject to temporary ups and downs, which happen to be food and fuel. It is an attempt to measure the long-run trend in the inflation rate. Also, if the food and fuel price increases become permanent, that will be reflected in the core rate as the price jumps work their way through the supply chain.

The bottom line: both the headline and core inflation rates are calculated and released each month by the federal government in the same publication. Readers can track one or both.

Some people keep meticulous records of what they buy and how much they pay. Some of these folks tell me their personal inflation rate doesn’t match the official inflation rate. Why not?

This is actually an easy question to answer. The officially calculated inflation rate is based on the buying experiences of a representative sample of consumers across the country. So it’s based on price changes experienced by the average consumer.

But, of course, no one is exactly average, so it’s not surprising that the inflation rate for any one person will be different than the reported inflation rate. However, this difference becomes more important when it is evident for an identifiable group of individuals.

One such group that has argued the official inflation rate consistently understates their personal inflation rate is the elderly. The elderly purchase more medical care services than the average consumer. Because medical care prices have typically risen faster than other prices, the inflation rate for elderly consumers will often be higher than the average inflation rate. This is why for years advocates for the elderly have argued for a supplementary inflation rate calculated specifically for the kinds of purchases made by older consumers.

Last, what about the apparent disconnect between the reported inflation rate and the rate most of us, in our gut, feel is occurring? Some of this is psychology. We tend to remember rising prices more than we do falling prices.

But some is also real and based on how our spending is allocated. Many of our expenses — house and car payments, insurance, TV cable and phone contracts — are fixed for a year or more. So we don’t see frequent price changes for these items. Hence, we tend to focus on prices that can change from day to day, like gas, food, clothing and personal items. It turns out that at least recently, these frequently fluctuating prices have been rising two to three times faster than all other prices!

Tracking price changes (the inflation rate) is actually more complicated than it might appear. Different measures exist for different uses. You will have to decide which one is best suited for you!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The College of Agriculture and Life Sciences communications unit provides his You Decide column every two weeks. Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide

Related audio files are at http://www.cals.ncsu.edu/agcomm/news-center/category/economic-perspective/

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