Forget what the government tells you about the inflation rate, known to economists as the CPI. The CPI may come into play when dealing with economical issues, but don’t expect your real expenses to increase at a rate nearly as low as the rate quoted by officials. First of all, the CPI doesn’t include food or energy, two items that are sure to be a major expense in most households. As crazy as this sounds, it’s by design. Not only that, but the method of calculating the inflation rate has changed over time; if the old rules were still in effect now, the official rate would have been much higher these past few years.
Right now, the official rate of inflation is around 3%. Meanwhile, gasoline prices rose 8% and food prices rose faster than inflation this year.
Food and beverage prices are rising at a 4.4% annual rate. But dairy prices are up 13% (and 26% for a gallon of whole milk alone), thanks to price supports and brisk exports of powdered milk. Meanwhile, meat prices are up 6%, and bakery products are up 4.6% because corn is being converted into ethanol instead of animal feed, muffins and sweetener.
Food and energy are two major expenses for many households. College tuition and health care costs have outpaced inflation, as well. If you take a look at your year end totals in Quicken or Microsoft Money, you’ll likely see that your expenses have increased much more than the 3% or so quoted by the government. Calculate your own inflation rate and use that for making decisions about where to cut back.
The discrepancy between economists’ calculations and any individual’s reality is to be expected—the CPI doesn’t measure personal expense inflation, it’s more of just a marker to signify one aspect of the economy. For all practical purposes, it is meaningless. Are your investments providing you a better return than the CPI? That is probably considered a low benchmark for investment performance, as you want your money to grow to at least match your purchasing power from the previous year. Unfortunately, it’s highly unlikely that, assuming a 3% inflation rate, everything you could buy for $1,000 this year will cost $1,030 next year. Investments will have to surpass the inflation rate significantly in order to provide the same real purchasing power.
photo: Stewart
Your Real Cost of Living [Kiplinger]
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sigh True. Milk has been particularly frustrating. Rice and beans have held pretty stable and they’re the basis for a surprisingly large number of our meals…(w/veggies and spices and such).
We spent a whole session in my college intro economics course discussing all the problems with the CPI. The index measures a basket of goods that’s updated once a decade. Not only does the price increase calculations cut out food and gas, it also doesn’t track the average consumer’s spending habits well.
My goal, as always, will be to save as much money as I can, regardless of inflation, market averages, or other metrics.
Hi CC,
A good posting. Thank you. I would point out one small fact, and thats that some investing instruments such as inflation linked bonds, are partially pegged to the CPI, so while its definetly meaningless for one’s budget, its not entirely meaningless for ones investments!
That said, thanks again for a relevant and well written posting.
Best,
James
Increasing energy prices are inflationary because it takes energy to produce everything else. Since we are still a mostly oil-based economy, when oil prices increase, so will most everything else. I have always wondered why the CPI removes this inflationary measure. Must be political.
Brycef: Perhaps you answered your own question—if oil affects the price of everything, wouldn’t including it in the index be superfluous? Maybe you’re onto something there.
James: Entirely true. Inflation-linked securities depend on the CPI—perhaps that’s another reason the government has an incentive to keep the reported rate of inflation as low as possible. It keeps the rate on certain bonds low so the government pays out less to those holding its debt.