If the inflation rate is calculated too low, will the economy seem to be growing when it is not?

Question/Comment: I am wondering if the government is calculating the inflation rate correctly. If the inflation rate is calculated too low, will the economy seem to be growing when it is not? Is there any measure of how accurate the government calculated inflation rate actually is?

Paul Solman: Man, are you asking the right person, Mr. Kasper. And I am relieved that you are asking. Here’s why.

About a month ago, we began shooting a story on this very issue. I’m in the process of scripting a version of it today, in fact. But it may or may not make air because “inflation,” as an issue, has been superseded by events. The greater worry now is DEflation. (See my response to the email from Mick Tarel of El Cajon, Calif).

You’re right to suggest that “if the inflation rate is calculated too low…the economy [will] seem to be growing when it is not.” That’s because “real economic growth” is growth minus inflation. If inflation is higher, then real growth will be lower.

My favorite champion of the view that inflation, as reported in the consumer price index or CPI, is UNDERSTATED is John Williams of shadowstats.com. Go to his website for details, but here’s his basic contention, as told to us is “had [the government] not made certain methodological changes…back in 1990, [inflation] would be about three percent higher…and if you look at the way the CPI was calculated back in 1980, the difference is closer to seven percentage points instead of three.”

The 1980 change replaced housing prices with rental costs. Prices then took off – a rise that wasn’t reflected in the CPI. The changes in the ’90s were more technical. We summed them up pretty well, if I do say so myself, in this piece from 1996.

There are some good arguments to suggest the CPI may since have been UNDERstated. But if so, it’s probably not by much. Housing prices have come down. So, of course, have commodities – most especially fuel and even food. In answer to your question, then, I’d take the CPI, add maybe a percentage point, and go with that as the overall inflation average. But remember, every group of people – every PERSON – has a different inflation rate, depending on what they buy. Those who live far from work spend more on fuel; those who are older, more on medical care; etc. YOUR inflation rate, in other words, could be lower or higher than the CPI.