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.
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.
