Consumer Price Index may not be realistic

from the Dallas Morning News

This provides a great history on explanation on the Consumer Price Index. The full article includes an online calculator to compute your own Price Index - Kale

By PAMELA YIP

It's one of those government reports we see every month.

But what does the Consumer Price Index really mean to you and me? And how closely does the CPI – which measures inflation at the consumer level – truly represent what you're spending for goods and services in your life?

To be honest, it doesn't always match.

The CPI measures the average change in prices paid by urban consumers for a market "basket" of goods and services. The basket includes expenses such as food, fuel, pet food, rent, cigarettes, college tuition, prescription drugs and haircuts.

Because the CPI is a statistical average, it may not reflect your experience or that of specific families or individuals – particularly those whose spending patterns differ substantially from the average urban consumer.

For example, consumer prices in June rose 5 percent from the previous June. In comparison, a typical married couple saw their inflation rate increase 5.3 percent, according to the U.S. Bureau of Labor Statistics.

"If someone spends a lot more money on food than the average person or if they spend a lot more on medical care, then their own personal inflation rate will be different," said Cheryl Abbot, regional economist at the bureau in Dallas.

"With transportation prices today increasing at a much faster pace than overall inflation, if you spend more on transportation than the average consumer, your inflation rate will be higher," Ms. Abbot said.

For example, transportation accounts for about 18 percent of the total CPI, but if it eats up 25 percent of your family's budget, the calculator will show your inflation rate to be higher than the actual CPI.

Mark Zandi, chief economist of Moody's Economy.com, an economic consulting firm, said there are numerous variables that will affect your individual inflation rate.

"What people spend their money on varies substantially by age, income, region and ethnicity," he said.

Rising food prices, for example, will take a bigger bite out of a lower-income consumer's budget than that of a higher-income person.

Your lifestyle is also a factor.

"Those higher fuel prices affect people very differently," said Michael Davis, a finance and economics professor at Southern Methodist University. "I live relatively close to campus, and there are three or four days a week that I ride my bike [to work]. Gas can go up and it doesn't make much difference in my budget. I fill up my gas tank twice a month, and some people fill up their gas tank twice a week."

Most consumers "feel that the CPI is currently understating the inflation that they are struggling with, since the prices for things they buy almost every day, like gasoline and bread, are rising rapidly," Mr. Zandi said. "In most times, the CPI is a good benchmark for the inflation most of us face. In times such as now, however, it is clearly less useful.

"In most times, prices across most goods and services rise at similar rates," he said. "Today, prices are rising rapidly for energy and food compared to prices for everything else, so that for those households that spend more of their budget on energy and food, the overall CPI is not representative of the inflation they face."

Economist Terry Clower agreed.

"When you have rapidly rising prices in certain key commodities, does that weighting in your basket of goods get changed fast enough so that it really reflects the true cost?" Mr. Clower asked. "It does not."

Though the CPI may not directly reflect what you're spending in your life, it's a crucial barometer in determining what certain consumers get in their pocket:

•The CPI is often used to keep rents, royalties, alimony payments and child support payments in line with changing prices.

•Many workers are covered by collective bargaining agreements that tie wages to the CPI.

•Payments to Social Security recipients, military and federal civil service retirees and survivors, and food stamp recipients also depend on the changes in the CPI.

•The government uses the CPI each year as a barometer to adjust federal income tax brackets, personal exemptions and standard deductions to reflect inflation.

Link to full article. May expire in future.