Wednesday, June 13, 2012

Measuring Inflation

Measuring the change of prices is a difficult task.  There is no way to obtain a completely objective overall change in prices.  Every measure will have some kind of bias, and can be argued to be over or underestimated. 

Over the decades there have been changes in the way the government measures the consumer price index (CPI).  One change was to incorporate substitution effects.  This means that if the price of steak increases, and people consumer more beef, then beef is now a larger part of the economy and should have a bigger weighting in the CPI.  A second change is to incorporate qualitative changes into the CPI.  Thus, if the computer speed doubles in 2 years, but the average computer price remains the same, then the CPI will record a reduction in price for computers.

I wanted to take my own measurement of inflation using items that would not be affected by either of these 2 changes.  I wanted to see how much smaller the government inflation number is compared to the modified CPI number.  I also wanted to see if there was a change from decade to decade from the 60s to the 2000s, to see if there is an increase in the difference between the two numbers over the decades as the government implemented more changes.

The modified price index includes 5 items: oil, 4 year public universities, medical prices, the price of houses, and the price of milk.

Below is an image of the government CPI as well as my modified CPI.

The modified price index tracks the CPI closely, but has greater variance.

The following is the summary data by decade.  Please note that the 60s only includes the years 1965-1969, and the 2000s only include 2000-20008.

Decade Modified CPI Official CPI Difference Percentage Difference
60's 0.042 0.037 0.005 0.138
70's 0.106 0.073 0.033 0.454
80's 0.055 0.053 0.002 0.040
90's 0.036 0.030 0.006 0.216
00's 0.087 0.029 0.058 2.043

The Modified CPI column is my newly calculated CPI's average increase for each decade.  The official CPI is the government CPI.  The difference is the modified CPI minus the official CPI.  The percentage difference is the difference divided by the official CPI.  It is interesting to note that the percentage difference doesn't change much through the 90's.  But there is a huge change in the 2000's, with the percentage difference over 200%.

Data is located here.

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