Hard to believe that $100 of money in 2002, would be worth $78.28 today in 2012, but that is case according to the Bureau of Labor Statistics’s website. There are so many ways to calculate inflation, but what is the best overall best inflation indicator?

Now of course many people would argue that these inflation numbers are actually a little bit light and that the way they are prepared has been altered to mitigate actual inflation. So what is the big picture of inflation number preparation?

There are two main ways of preparing inflation numbers.

Consumer Price Index (CPI) or core inflation” through calculating a Personal Consumption Expenditure (PCE) price index.

The Bureau of Labor Statistics number used above is based off CPI, which is based off a basket of goods (including food). The exact description from the Bureau of Labor Statistic’s website is:

The CPI represents all goods and services purchased for consumption by the reference population (U or W) BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups. Major groups and examples of categories in each are as follows:

  • FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)
  • HOUSING (rent of primary residence, owners’ equivalent rent, fuel oil, bedroom furniture)
  • APPAREL (men’s shirts and sweaters, women’s dresses, jewelry)
  • TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)
  • MEDICAL CARE (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services)
  • RECREATION (televisions, toys, pets and pet products, sports equipment, admissions);
  • EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);
  • OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses)

 

Personal Consumption Expenditure (PCE) is similar, but it excludes goods that are highly subject to “inflation volatility”, such as food and energy.

Some fun facts:

  • CPI (which includes food/energy) is used for social security cost of living adjustments.
  • Starting in 1983, housing prices do not affect CPI at all. Housing prices were replaced by “owners’ equivalent rent”
  • PCE is generally considered a better “long-term indicator” of inflation.
  • There are “variety of CPIs,” including “trimmed CPIs.” Trimmed CPIs have set ranges that are reduced by a selected percentage to allow for more accurate inflation numbers.
  • Historically, there has always been people who believe inflation is both under and over estimated. Many say that inflation is simply overestimated.

I however would argue that inflation is happening in our daily lives, but that inflation can be sneaky, especially in food. I submit to you, that the best inflation indicator for food (and maybe more than just food) is Lunch meat sold at your deli counter.

The primary reason I believe Lunch Meat is the best inflation indicator.

  • Lunch meat is sold in units of one pound. You tell the deli counter, you want an amount in denominations of pounds. This is unlike other pre-packaged foods that can reduce their size (e.g. from 16 ounces to 12 ounces).
  • Lunch meat is made of meat. Meat that takes energy and numerous supplies to create. It takes a host of materials and components to produce meat within our country. This results in a fairly diverse representation of inflation within each component. Perhaps grain to feed the cattle is more expensive, the hourly rate of butchers increases, etc.

Of course figuring out how bad inflation truly is to an individual can be a very complex task.  For instances, I personally believe that in the near future Social Security will suddenly become pegged to PCE and not CPI, but this is purely speculation. This of course could result in a stealthy reduction of cost of living adjustments for my potential future benefit.

Final thought, a while back, I remember making the comment to my father about “Owning a home during a time of inflation can actually be a winning scenario,” and he replied “no one wins with inflation.” That really is the truth.

best inflation indicator

Filed under: Investing

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