The High Cost of Low Inflation

Inflation in the US isn't a problem... unless you happen to eat, drive a car, or rely on any other service that factors in the cost of gasoline. If you do, you're likely to question the validity of the monthly Consumer Price Index released last week by the US Department of Labor's Bureau of Labor Statistics.

US consumers paid more in March for food and gas. But otherwise, inflation was mild, the BLS boasted. The consumer price index only rose 0.3% last month, down from February's 0.4% rise. Gas prices increased at a slower pace than the previous month -- and if you simply exclude the volatile categories of food and gas, so-called "core" prices increased only 0.2% in March. Woohoo!

But wait a minute. How does it make sense to base the national inflation rate on a statistic that ignores the rising costs of fueling up our cars and ourselves -- two things most Americans do on a fairly regular basis. Even people who don't drive are likely to depend on some kind of public transportation that relies on some form of refined fuel oil. And it's safe to say that almost every consumer good is affected by transportation costs, which are increasing because of increases in the price of fuel.

Which brilliant economists and policy makers -- likely from the Federal Reserve -- decided that "core" prices should exclude the hard-to-ignore costs of energy and food? But while food is excluded, it somehow makes sense to factor in the price of alcohol, tobacco, and funeral expenses -- what one person defined as part of a bizarre grab-bag of odd fellows included in the CPI?

What percentage of Americans still buy tobacco or have the misfortune of worrying about funeral costs on a regular basis? More probably buy alcohol -- especially in light of the overall economy. But it still makes me wonder. Why are we more interested in the cost of beer and whisky than the price of milk and coffee? As financial advisor Doug Short noted in his look at the Consumer Price Index, core inflation, by the federal government's definition,

...is a somewhat peculiar metric in that one of the exclusions, Energy, is an aggregate that combines specific pieces of two consumption categories: 1) Transportation fuels and 2) Housing fuels, gas, and electricity. The other, Food, is the major part of the Food and Beverage category. I should explain that "beverage" for the BLS means alcoholic beverages. So coffee and Coca Colas are excluded from Core Inflation, but Budweiser and Jack Daniels aren't.

Go figure. And then do something really dramatic. Go grocery shopping.

Last weekend I decided to price a selection of groceries at multiple stores in and around the New York City area. Everyone knows that the prices in Manhattan are unusually expensive: Where else can you pay as much as $7.99 for an eight-ounce container of Kraft parmesan cheese or $5.99 for a 59-ounce carton of Tropicana orange juice? The average prices for those same products last year in Manhattan were $6.84 and $4.60, respectively, according to the ACCRA Cost of Living Index published by C2ER, the Council for Community and Economic Research, in Arlington, Va.

And even in New York City's outer boroughs, which traditionally have slightly lower prices than Manhattan, and in neighboring bedroom communities in New York and Connecticut, food prices are decidedly higher compared with last year. A 16-ounce roll of Bob Evans Original Sausage climbed from $4.99 to $7.29 in the past three months in Westchester County, N.Y. And many grocery products are once again shrinking: Manufacturers are scaling back sizes, decreasing the amount of product without an equal drop in the retail price. Those 184-count boxes of Kleenex tissues are likely to have 174 tissues now. And that five-pound bag of Domino granulated sugar? Look closer. It may only be four pounds.

While the federal government argues inflation is in check, naysayers like Texan Congressman and Republican presidential candidate Ron Paul claim the statistics are invalid. (Just weeks ago, Paul made headlines when he accused Fed Chief Ben Bernanke of lying to the American public about inflation.)

But the controversy over the disparity between the CPI and the reality of most Americans is not new. As far back as 2004, Pimco bond fund manager Bill Gross was arguing that "Americans are being in effect conned by their government and falling behind the inflationary eight ball year after year."

Even before Gross, the late Peter Bernstein, a financial historian and economist, suggested the same thing: "What people see and feel as inflation is what they pay for services and non-durables," not hedonically adjusted durable goods such as computers and DVDs.

"Hedonics," in economics, is the concept that if something is better than it used to be, it is effectively cheaper. As trader Deepak Shenoy explained on Quora:

The concept is: If a laptop with an 800 Mhz processor was retailing at $700 five years ago, and today you can get a laptop with a 1.6 Ghz (1600 Mhz) for the same price, the inflation calculators say that you have received more value for the same price, therefore let's adjust the price down, to say $500. That means that a laptop price has actually fallen by $200.

But what happens if you try to buy that $700 laptop for $500? Right. You're escorted out of the store.

This week, the American Institute for Economic Research (AIER) issued its latest "Everyday Price Index," which measures the day-to-day costs of items people buy on a regular basis. The EPI found prices actually increased 1.9% in March (prior to seasonal adjustments), more than double the Bureau of Labor Statistics' CPI increase during the same period. In the past 12 months, the EPI increased 4.1%, compared to the CPI increase of only 2.7 percent.

Steven Cunningham, director of education and research for the AIER, an independent organization that developed the EPI earlier this year, noted that while the CPI includes big-ticket items like cars, appliances, and houses, the EPI accounts for just the items people buy regularly.

That means the EPI more closely reflects the price shocks consumers experience at stores and in their household budgets.

The EPI rose 1.1% in February and 1.3% in January, compared to the CPI's increase of 0.4 percent during the same months. AIER research fellow Polina Vlasenko explained that consumers will continue to struggle with higher costs, noting, "Consumers remain under serious pressure to stretch tight budgets even further to cover their basic needs, and unfortunately, that trend doesn't show signs of stopping anytime soon."