I got quite a bit of negative feedback to my post Calculate Your Personal Inflation Rate because in it I stated that inflation numbers are not, in fact, manipulated by the government.  Well, that statement really upset the tin-foil-hat conspiracy theorists.  I got a few emails telling me how wrong I am without any supporting evidence.  I got some others accusing me of being a “government shill,” whatever that means (I have never worked for the government or a government contractor nor do I stand to gain personally from lying about inflation).  I got yet more emails whose authors at least went to the trouble to put together something resembling  a coherent argument.  Kudos to them.  As it turns out, most “the government lies about inflation!” theories revolve around a few common misconceptions and flat-out falsehoods.  Since I enjoy stirring the pot, here are my rebuttals to a few common criticisms (some culled from email and others from this editorial on gold-eagle.com.  Keep in mind that gold-eagle.com, unlike me, has a vested interest in spreading the idea that the government lies about inflation. 

Misconception:  The government excludes food and energy prices from official CPI, which understates the true inflation rate
No they don’t.  This is an extremely common argument and it’s also the easiest to prove wrong.  These people, of course, are refering to Core CPI numbers often reported by the media.  It is true that core CPI excludes volatile items such as food and energy because the short-term volatility of those items can make it difficult to determine what price increases are due to short-term supply and demand imbalances and which are due to a systemic rise in price, which is what the CPI was designed to measure.  However, core CPI is a inflation index, not the inflation index.  The CPI-U For All Urban Consumers is the most comprehensive CPI index, and is widely reported along with core CPI by the government and media.  In fact, I don’t recall many instances where Core CPI was reported where CPI-U wasn’t.  You might find this hard to believe, but CPI-U does include food and energy costs.  It includes shelter as well.  In fact, pretty much the only thing it doesn’t include is the street price of illegal drugs, although they may find a way to measure that soon.  The CPI-U is prominently displayed on the BLS website and widely reported by the media, so it’s more than a little intellectually dishonest to point at the core CPI and claim the government is deliberately excluding food and energy prices to mislead the public.  Anybody with an internet connection, a newspaper subscription, or a television set can easily see otherwise.

Misconception:  The Federal Reserve stopped calculating M3 money supply in order to hide how much money is being printed from the public
The Federal Reserve did actually stop calculating M3, but it wasn’t to mislead the public.  According to the Fed press release,

“M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.”

There you have it directly from the horse’s mouth, M3 was discontinued not to mislead anybody, but because it was expensive to produce and judged by the Federal Reserve Board to be a useless measure for their purposes.  Shouldn’t we be happy a government agency voluntarily chose to cut costs and not waste our tax dollars?

“Ah hah!” says the conspiracy theorist right about now.  “You’ve been fooled!  The cost-cutting crap is just an excuse.  The real reason they discontinued M3 is to hide from the public how much money is being pumped into the system!”  Well, that argument doesn’t hold water for several reasons, chief among them being that M3 was never made unavailable.  As it turns out, the Federal Reserve was never the only institution that calculated the M3 money supply, so the fact that they don’t anymore does not make M3 any more difficult for the public to obtain.  Furthermore, if you read the press release cited above, the Fed still reports all the components used to calculate M3 and the formula is taught in Economics 101 textbooks, so you could actually calculate it yourself pretty easily using Excel.  There have always been and still are plenty of sources calculating M3.  Here is one of my favorite sources that calculates M3 using data from official sources.  If this is a conspiracy to lie to the public, they’re doing an extraordinarily horrible job.  If the Fed really wanted to hide M3, they would stop releasing the component data.  Any 5th grader could calculate M3 given the component data, so it’s not like you need a PhD in quantitative methods or anything.

This rebuttal doesn’t even deal with the fact that growth in the M3 money supply is not equivalent to consumer price inflation, so the entire premise that the government could actually cover up inflation by lying about M3 growth is a false premise to begin with.  Many people think growth in the money supply is the same thing as consumer price inflation, but this is false.  There are two kinds of inflation, monetary inflation (growth of money supply) and consumer price inflation (systemic rise in the price level).  In a closed monetary system, monetary inflation and consumer price inflation are equivalent.  Luckily, we do not have a closed financial system.  We can import foreign currencies and export dollars at will, which changes the equation dramatically.  The differences between monetary inflation and consumer price inflation and how they influence each other can be subtle and belongs in another post.  I plan on writing about it shortly, but for the purposes of this debate, it’s only important to know the two are not equivalent.

Misconception:  The government uses hedonic adjustments to understate inflation
Like the M3 misconception, this one has a kernal of truth, but the implications are completely misinterpreted due to lack of experience in statistical methods and a fundamental misunderstanding of what exactly inflation is and how it’s calculated.  A hedonic adjustment is a substitution of one product for another.  The theory goes that if steak gets too expensive, people switch to hamburger.  Since people don’t eat as much steak, its weighting in the CPI goes down and that of hamburger goes up.  This, according to the conspiracy theorists, is a lie.  But those people don’t understand what inflation actually is and how it is measured.  Inflation is a systemic rise in prices across the board as represented by actual consumer behaviour.  It is not meant to reflect the rise or fall of any particular product but rather a representative basket based on what consumers actually spend their money on.  Some argue that lowering the weight of steak and raising the weight of hamburger understates inflation because it reflects a lower standard of living.  That is an illogical statement for two reasons,

1. Whether or not hamburger reflects a lower standard of living is subjective to begin with.  Just because you prefer steak doesn’t mean everybody else does.  Furthermore, they may prefer steak but cut back in order to spend more money in another category due to reasons having nothing to do with rising prices.  This represents a personal choice by the consumer, not inflation.
2. Following that argument to its logical conclusion, the situation quickly devolves into one where we’re tracking the cost of buggies and butter churns in an age of automobiles and stainless steel appliances.  It makes no sense to heavily weight a product no longer widely used, regardless of the reason it’s fallen out of favor.  The fact is, there is no way to tell for sure why consumers buy more or less of any given item.  In the case of horse-drawn carriages, it’s obviously because the technology is obsolete.  In the case of steak, who’s to say it’s due to price rather than changing consumer preferences?  Such shifts in preferences happen all the time and to simply assume it’s always due to price is absurd.

There are enough misconceptions about the CPI to fill a large book, and I’ve barely scratched the surface here.  In particular, I haven’t yet covered quality adjustments, weighting methods (the BLS switched from the arithmetic to geometric mean to determine category weightings), and the effect of oil and commodity prices on future inflation.  There are dozens of others I haven’t mentioned because I haven’t had a chance to do the requisite research on them yet.  I intend to revisit the subject regularly in the future as the public debate unfolds.  If you have a suggestion on a related topic to write about, a question, a criticism, or anything else to say on the subject, please leave a comment.  I will try to address all of them either in a comment or in a new post.

Update:  Check out this post by Debt-Free Revolution for an opposing view.

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