Real Rate of Inflation
Inflation in the USA is at its highest in four decades. Inflation is measured by comparing how much a set of good sells for today versus how much it sold for a month, year, or years ago. That having been said, measuring inflation is complicated. Methods change over time. The real rate of inflation experienced by one demographic group like retired people on pensions in rural areas as opposed to twenty-year-old urban workers commonly varies. Thus, adjustments of things like Social Security Payments based on the consumer price index may or may not adequately account for price increases experienced by the recipients.
What Is the Consumer Price Index?
The most commonly cited index of inflation is the Consumer Price Index also called the CPI. It is compiled by the US Bureau of Labor Statistics. The CPI-U or primary CPI is set up to follow urban consumer price changes. This index is used because it represents 93% of the US population. The index is put together by measuring prices of 80,000 separate items each month. It is an average that does not precisely represent the experience of any particular consumer sub-group.
Consumer Expenditures Survey
The index uses the consumer expenditures survey to take into account the price of gasoline, grocery store items, visits to the doctor, and many more goods and services. The relative “weight” of each item is assigned based on the relative importance of that item in individual spending. There are various CPIs for different sub-groups. Adjustments for Social Security benefits are based on the CPI for Wage Earners and Clerical Workers and not on a CPI based on retirees or disabled individuals who are the folks who receive Social Security Payments. The Survey looks at both housing costs and the costs of goods and services each month.
Tax Bracket Adjustment for Inflation
In 2017 Congress passed a law changing the CPI used for tax bracket adjustment for inflation. Rather than using the standard CPI it uses the Chained Consumer Price Index for All Urban Consumers. The Chained Consumer Price Index for All Urban Workers has its weighting of prices updated more frequently than the index for all urban consumers and the index for urban workers. An example would be how much people pay for a telephone land line versus cell phone service as the world has largely switched over to smart phones in the last few years. When the price of beef goes up people will tend to buy more chicken. The chained index picks up on this right away while the other indices do so much more slowly.
Personal Consumption Expenditures
Another measure of inflation produced by the US Bureau of Economic Analysis measures personal consumption expenditures. It considers more that money paid out of pocket as in the CPI. For example, it looks at how much of a worker’s health insurance is paid for by an employer, Medicaid, and Medicare as well as insurance premiums and out of pocket costs for doctor visits. The PCE shows health care costs going up more than reflected by the CPI and can be a better measure when considering older people with a larger proportion of medical costs in their budget. The FED uses the PCE as opposed to the CPI when setting a long term target of 2% for inflation.
What Is Core Inflation?
Food and energy prices tend to be more volatile than other goods and services. By removing them from the equation a core inflation number is reached which experts say is a better measure of where inflation is going. The Cleveland Fed developed a trimmed mean CPI that removes items with the most-extreme monthly changes and the median CPI which only considers items in the middle range of variation. When the price of cars went up due to chip shortages the core CPI went up 3.8% while the trimmed-mean CPI went up 2.6%.
Price, Quality, Where You Spend Your Money
Something that the CPI and PCE ignore is that the quality of items in the mix may get worse when cheap imports become dominant, and quality may get better as companies like Apple and Samsung improve their cell phones. New technologies often make life better, more efficient, and more profitable. Another aspect of inflation is how it affects your investing and trading. People who spend all of their available money each month in order to survive are more prone to injury from inflation than those individuals who have a great deal of money for digressionary spending including investing. The stock market commonly outruns inflation and successful options trading trumps the stock market for beating inflation. Sign up with one of the trading squadrons at Top Gun Options and worry less about how inflation is calculated and how high it goes.