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According to Shadow Government Statistics, inflation in the USA is around 11%, not 3% as the official statistics claim, as shown in this chart:

Alternative Inflation Chart (source)

In fact, they suggest that the US government is manipulating the data:

Have you ever wondered why the CPI, GDP and employment numbers run counter to your personal and business experiences? The problem lies in biased and often-manipulated government reporting.

The caption associated with the chart claims the following (with my emphasis):

The CPI chart on the home page reflects our estimate of inflation for today as if it were calculated the same way it was in 1990. The CPI on the Alternate Data Series tab here reflects the CPI as if it were calculated using the methodologies in place in 1980. In general terms, methodological shifts in government reporting have depressed reported inflation, moving the concept of the CPI away from being a measure of the cost of living needed to maintain a constant standard of living.

The CPI-U (consumer price index) is the broadest measure of consumer price inflation for goods and services published by the Bureau of Labor Statistics (BLS).

While the headline number usually is the seasonally-adjusted month-to-month change, the formal CPI is reported on a not-seasonally-adjusted basis, with annual inflation measured in terms of year-to-year percent change in the price index.

In the charts to the right we show two SGS-Alternate CPI estimates: One based on the pre-1990 official methodology for computing the CPI-U, and the other based on the methodology which was employed prior to 1980.

The implication of Shadow Government Statistics is that the USA has changed the method they perform calculations of inflation to deceive the US people.

Why did the US change how it calculates and reports inflation? Is the new method more useful than the old (e.g. is a 2% inflationary target for monetary policy at the US Fed more effective under this new calculation), or does the new method merely mask underlying economic problems that the government wishes to hide from its population for political reasons?

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    It's unclear to me what claim you are skeptical about. Do you doubt that the US government changed their model? Do you doubt that the red SGS line represents the old model? That a metric was refined, and someone didn't like it doesn't seem on-topic - maybe this belongs on Economics.SE? – Oddthinking Feb 9 '12 at 14:01
  • The Shadow Government Statistics website claims that the changes were made to deceive people. The government claims that the new method is better. I am skeptical of both. – Brian M. Hunt Feb 9 '12 at 14:18
  • Does that help? :) – Brian M. Hunt Feb 9 '12 at 14:48
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    FYI - The reason why the government has an interest in reporting low inflation rates is because many of the entitlement programs are tied into that rate. So if the CPI went up 2%, it costs the government 2% more. If it goes up 10% it costs 10% more. However, not only have they changed the model but they change the basket of goods all the time in order to keep the numbers lower than they are. – Dunk Feb 9 '12 at 20:26
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    @Dunk: Perhaps most importantly, the overnight lending rate of the US Federal Reserve is determined by the target inflation rate (namely 2% CPI). – Brian M. Hunt Feb 9 '12 at 20:58
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First, let's imagine that Shadow Government Statistics is correct and that the inflation was around 10% in 2006. It would mean that the real interest rate on Treasure Bills would have been of approximately -6%, which is insane. No one would have bought them, if that was the case.

Wikipedia defines real interest rates as follows:

The "real interest rate" is the rate of interest an investor expects to receive after allowing for inflation. ... If, for example, an investor were able to lock in a 5% interest rate for the coming year and anticipated a 2% rise in prices, he would expect to earn a real interest rate of 3%.

If, as Shadow Stats claims, the inflation in the United States was up to 10% and the interest rate on Treasure Bills was of about 4% (source), then the real interest rate would be negative (4%-10% = -6%). Under a negative real interest rate, people lending money to the government would be losing money whereas the US government would be earning money by borrowing. It would make no sense to lend money at such a low rate, yet demand for Treasure Bills remained relatively stable during 2006.

Such a situation would be unsustainable. Eventually, lenders would wise up and stop lending until the real interest rates go back up. It makes no sense for people to invest at a negative rate of return. If inflation was that high, then interest rate would increase as well for to at least positive returns on investment.

That is the most obvious reason Shadow Government Statistics is wrong: if they were right, Treasure Bills would be ways to give money to the US government rather than an investment.

Now, what did Shadow Stats did do to arrive to such values and how is it superior to the Bureau of Labor Statistics' methodology? I can't say. While they have promised to that their methodology will be "published in next month’s 'Reporting Focus'" back in October 2005, I can't find that month's "Reporting Focus" - or any detailed methodology - anywhere on their site.

Based on their criticism of the Bureau of Labor Statistics, we can make a few educated guesses though.

Back in August 2008, the Bureau of Labor Statistics published an article called Common Misconceptions about the Consumer Price Index: Questions and Answers to which Shadow Government Statistics felt need to reply to in ShadowStats.com Response to BLS Article on CPI Misconceptions.

In the response SGS goes into details into why he believes the BLS is biased and underestimates inflation. He blames three factors, which are well summarized in this Forbes article:

  1. Substitution. If steak becomes more expensive, and you buy hamburger instead, then the Bureau of Labor Statistics reasons your cost of beef has stayed the same – no inflation!

  2. Hedonics. If the 2011 model of a car costs more than the 2010 model, but it also comes with more standard equipment, the BLS reasons you’re still getting the same value for your money – no inflation!

  3. Geometric weighting. Nothing fancy here: If the price of something goes up, the BLS simply makes it count for less in the CPI relative to everything else. If the price comes down, it counts for more. Voila!

The idea that the CPI is biased is hardly new or controversial.

In fact, such is taught in economic textbooks (Introduction à la macroéconomie moderne, p. 148-149) and the Bank of Canada even has a section of its website dedicated to explaining its shortcomings:

Commodity-substitution bias

One reason is that the change in the CPI measures the cost to the consumer of buying a fixed basket of goods and services, the contents of which are updated only once every four years. In reality, consumers can and do substitute cheaper items for those that become more expensive when the relative prices of different products change between basket updates. For example, if the price of beef rises sharply, consumers may buy pork or chicken instead, if they are cheaper. Because of this shift in spending patterns, the actual increase in the overall cost of living is less than the increase in the cost of buying the original fixed basket. So, the true cost of living can be overstated if there is a commodity-substitution bias.

New-goods bias

New products (e.g., high-definition TVs, digital cameras) that come onto the market between updates of the consumer basket can also be a source of measurement bias. Typically, the relative prices of some of these new products (notably home electronics) drop considerably following their introduction. If those price decreases happen before the basket is updated to include the new goods, the overall CPI will overstate the true cost of living (by an amount that depends on the share of the new goods in total spending).

Quality-change bias

The CPI aims to measure the pure price change of a basket of consumer goods and services of constant quality by comparing their prices at two points in time. In fact, quality improvements may decrease the prices of certain items. For example, rapid technological advances have resulted in lower prices for personal computers, as well as an increase in computing capacity. Although Statistics Canada uses various methods to correct prices for quality changes, such adjustments may not fully remove the bias, leaving the overall CPI overstated if quality improvements occur faster than they are measured.

Outlet-substitution bias

The entry into Canada of new discount retailers and large warehouse stores has resulted in shifts in market shares from high- to low-price retailers. If the effect of these shifts on the prices paid by consumers is not fully captured, the true cost of living will be overstated.

In other words, the notion that the CPI imperfect or biased is in line with mainstream economics. The critique by SGS overlaps with the admission of bias by the Bank of Canada but this is where the agreement stops. When we go into discussing the size of the bias or its possible solutions, mainstream economics and Shadow Government Statistics disagrees.

First, when economists try to measure the bias of the CPI, they arrive at under 1%, which is obviously quite far from the seven or eight percentage point bias that SGS's figures entail. For example, in Measurement Error in the Consumer Price Index: Where Do We Stand?, the authors conclude that:

In total, we estimate that the CPI overstates the change in the cost of living by about 0.6 percentage point per year, with a confidence interval that ranges from 0.1 to 1.2 percentage points. Roughly half of this bias is accounted for by the CPI's inability to fully capture the welfare improvement from quality change and the introduction of new items. Our bias estimate is smaller than that found in several earlier studies, in part because the BLS has recently made a variety of improvements to its procedures; our study highlights several potential areas for further improvement.

Secondly, many times on its website, Shadow Government Statistics says its inflation estimates are "based on methodologies in place as of 1980 and as of 1990." If that's the case, previous studies into the measurement error of the CPI during that time period will be enough to validate or debunk the SGS's numbers.

Well, according to The Consumer Price Index as a Measure of Inflation which analyzes the bias of the CPI between 1967 and 1992, the bias is in the order of 0.5% at the highest. That's within the margin of error of the previous results. (Note: If we look into the bias prior to 1982, however, the bias is greater.)

In Conclusion:

The claim that the Bureau of Labor Statistics underestimate inflation by seven or eight percentage points is extraordinary, as it would imply that most investors are losing money by lending at a negative real interest rate. As their methodology is not published on their website, as their critique of the current way CPI is calculated is mostly congruent with mainstream economics and as economic analysis only measure a bias of 1%, it is unlikely that Shadow Government Statistics is correct in its belief that inflation is still around 10%.

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    @Oddthinking: As different stores price goods differently, it's important for Statistic Canada to know not only which goods are bought but where they were bought. Outlet-substitution bias occurs shifts to lower or higher priced stores in not properly handled. – Borror0 Feb 10 '12 at 2:02
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    "That is the most obvious reason Shadow Government Statistics is wrong: if they were right, Treasure Bills would be ways to give money to the US government rather than an investment." - Isn't this rather precisely what they are claiming, though: that the statistics have been manipulated to get people to buy treasury bills? I'm not saying that they're right, but when they're claiming a conspiracy, a claim that this would imply a conspiracy and that people would see through it hardly proves them wrong. – Random832 Feb 10 '12 at 18:22
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    @Random832: The case that I was making in the first quarter of the post is that, not only are they fooling "the population" but they are also fooling everyone who lends at interest rates (banks, credit banks companies, etc.) because inflation causes nominal interest rates to increase, in order to keep real interest rates steady. We're talking about fooling successful institutions and individuals into highly diminished profits. That is what makes their claim extraordinary. Maybe I should be clearer on that point. – Borror0 Feb 10 '12 at 21:06
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    Sorry, but there is huge fallacy in this argument, due using Wikipedia as a source. It's assumption that depreciation (the rate at which currency looses it's value) is same as inflation (increase of consumer prices). There are not. Depreciation is directly bound to the currency. However inflation is bound to the local market, may vary from between regions which use same currency (vide: eurozone). Real interest rate is in fact nominal interest rate minus depreciation rate. Depreciation is closely correlated to inflation, but they are not the same thing. – vartec Feb 13 '12 at 17:19
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    @vartec: How about economics textbooks written by PhDs in macroeconomics? "Le taux d'intérêt réel est le taux d'intérêt nominal ajusté pour éliminer les effets de l'inflation sur le pouvoir d'achat de la monnaie. En gros, le taux d'intérêt réel est égal au taux d'intérêt nominal moins le taux d'inflation." Introduction à la macroéconomie moderne, 4e édition, p.205 – Borror0 Feb 13 '12 at 17:38
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One should be skeptical of Shadow Government Statistics.

In researching Is inflation in the US higher than government statistics suggest? I could not find any record of Shadow Government Statistics releasing its methodology, despite promising to do so as long ago as 2006 .

MIT's "Billion Prices Project" is a more transparent project to track inflation. It seems to track slightly higher than the CPI but considerably lower than the Shadow Government model.

The BLS does allow shifting of goods within a category, i.e., "Apples in Boston" can switch from one type of apple to another. The justification is that within these categories, consumers will likely shift from a particular type to a generally-comparable type in the face of a relative shift in prices ("Wow, Red Delicious have gone up. Gee, a Goldrush is cheaper, that's good.") The criticism is that change is change and they ought to trace the exact same basket of goods.

A broader criticism is that these changes amount to "switching hamburger for steak". The BLS response at says:

Substitution is only assumed to occur within basic CPI index categories, such as among types of ground beef in Chicago. Hamburger and steak are in different CPI item categories, so no substitution between them is built into the CPI-U or CPI-W. .... In using the geometric mean the BLS is following a recognized best practice for statistical agencies. The formula is widely used by statistical agencies around the world and is recommended by, for example, the International Monetary Fund and the Statistical Office of the European Communities.

  • Yep. I have also half an answer written, and to write the second half I have to see their methodology but I can't find it. Their number makes absolutely no sense, but I feel bad at just stopping there. – Borror0 Feb 9 '12 at 19:47
  • I think this answer goes a long way to discrediting the SGS claim. I would feel more comfortable marking this as the answer if there were some reference to a rational explanation of how the changes to calculating CPI is beneficial. – Brian M. Hunt Feb 9 '12 at 22:27
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Yes. The government purposely does not include food & energy costs in the core CPI, because they are 'too volatile', and 'makes it hard to measure inflation', while the correct procedure would be to include them and use a moving average.

In addition to the All Items CPI, BLS publishes thousands of other consumer price indexes. One such index is called "All items less food and energy". Some users of CPI data use this index because food and energy prices are relatively volatile, and these users want to focus on what they perceive to be the "core" or "underlying" rate of inflation.

Source: Bureau of Labor Statistics

Another answer claimed that no one would buy treasuries with a negative real interest rate, however if you have billions of dollars, there is little choice where to park such a large amount of money besides treasuries. They are very liquid. Cash could be caught in a fire. FDIC insurance limit is < $1M. Banks go under. Gold is more volatile and difficult to transport. People are afraid of Eurobonds. No other country has the same liquidity. In fact, the nominal interest rates on treasuries DID go negative.

Yahoo chart

Source: Yahoo Chart (Sorry apparently the log-based charts can't display negatives.)

Bill Gross of PIMCO (manager of trillions in bonds) does not recommend US treasuries, and believes they are a trap. He underestimated the fear people had about Eurobonds, causing treasuries to rise, so has decided to buy some US treasuries after all, but not for long term.

Yes it is unsustainable, however like an avalanche or earthquake, no one can predict when the tipping point is. It is estimated to be 90% debt-to-GDP as the limit.

  • Chloe, I agree that the two link limit for new users is a pain. You'll overcome it soon when you get a few up-votes. In the meantime, please don't make me have to give the "mind your language, please" speech. It always makes me feel like a hypocrite. – Oddthinking Mar 25 '12 at 12:02

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