The New CPI Is Better, More Precise Than the Old CPI

In a comment Thomas Blair said: "The way CPI is calculated has changed, which makes comparisons between eras or even years irrelevant."

An anonymous commenter writes "Your reasoning is so specious. Firstly you have to recognize that inflation [CPI] is measured differently from the 70s so you're comparing apples to oranges."

The BLS provides CPI data here going back to 1978 using the new CPI-U-RS, which allows for a comparison of inflation calculated in the late 1970s using the old CPI (CPI-U) to inflation calculated using the new CPI (CPI-U-RS), see top chart above for a comparison of the two different CPIs between 1977 and 1998 and bottom chart for a comparison of inflation rates from December 1978 to December 2007 (blue line is inflation using the old CPI and red line is inflation using the new CPI).

Yes, it is true that the old CPI overstated inflation (see top chart above) and it is true that inflation was overstated in some years using the old CPI (see 1979, 1980 and 1981 in bottom chart, when the blue line is above the red line), but then actually understated inflation in the 1983-1984 period (blue line is below red line), and was about the same using either method for most of 1982 and in 1985-1986.

Bottom Line: The old CPI slightly overstated inflation, and revisions were made to correct for the slight upward bias and make the new CPI a more accurate measure of inflation. Some reports seem to suggest that the new CPI creates a downward bias for the way inflation is now reported, and that it would be higher today if it was calculated using the old, upwardly biased method. I think it's better to think of today's CPI and inflation rates as being better, more precise and more accurate measures than those in the past, and any adjustments should be made to previous years' inflation, not today's rates.

Further, I don't think the differences in the old CPI-U and the new CPI-U-RS are meaningful in any way that contributes to the discussion about comparing today's inflation to the 1970s inflation. It's far from a specious, irrelevant, apple to orange comparison, it's much more like comparing one variety of apples to a newer, better variety of apple. Inflation in the late 1970s was at double-digit level by either CPI, and inflation today, measured more accurately than ever before, is nowwhere near double-digits.

Some of the recent CD discussion has focused on the possible difficulties of comparing today's inflation rates to the inflationary 1970s period because of the changes that have been made to the way the BLS calculates the CPI. There was also some discussion about the timing of the changes to the CPI. Thanks to CD reader Spencer for the suggestion to check the BLS website for a comparison of the CPI-U-RS series (new) vs. the CPI-U series (old).

I was able to locate the BLS study "Consumer Price Index Research Series: Using Current Methods, 1978-1998," which finds that "the measured rate of inflation would have been lower since 1978 if methods currently used in calculating the Consumer Price Index for All Urban Consumers had been in place from that year to the present."

In other words, the old BLS method of calculating the CPI-U overstated inflation (which has been taught in Principles of Macro for decades), and various adjustments (14 in all, see Exhibit 1 in the study) made between 1983 ("changed homeowners’ component from cost of purchase to to value of rental services) and 1999 (the last 5 in 1998-1999 were maybe in response to the 1996 Boskin Commission Report?) attempted to make the CPI/inflation more accurate.

How big were the changes between the old CPI-U and the new CPI-U-RS after the 14 changes? Table 2 above tells the story:

1. Although most changes to the CPI lowered inflation rates under the revisions, some of the changes to the CPI actually increased inflation rates (see the row above titled "Effects of all other changes" that adjusted for the fact that the old series "understated" inflation in some ways).
2. Although the net effects in each period above were negative, meaning that inflation was overstated under the old methodology, the differences in inflation rates were relatively minor. For example, inflation from 1978 to 1982 averaged 9.46% annually under the old method and 8.46% under the new method, suggesting that the old method overstated inflation by about 1% per year.

For the other periods, the annual differences between old and new CPI inflation were relatively lower: -0.13% from 1983-1986; -0.35% from 1987-1997; and -0.23% in 1998, or an average of about 1/4 of 1% per year!

Bottom Line: With reasonable accuracy, we can fairly compare today's inflation rates calculated from the CPI-U-RS used by the BLS today to the inflation rates of the 1970s that used the old CPI-U, with a possible difference annually of only about 1% at the most. In other words, if you subtract 1% from the double-digit 10-14% annual core inflation in the mid- and late-1970s, you still get inflation way, way higher than the 1.5%-2.5% range of core inflation over the last ten years.

My position remains that unless, and until, we have core inflation approaching double-digits, inflation is not a problem. And I don't think there is near enough of a difference between the old CPI-U and the new CPI-U-RS to have that issue make any significant contribution to the inflation discussion.

Comments

[notsosmart:]

its all bs. for most people inflation is the cost of the 5 daily basic needs.gas,util,food,he... rate of inflation for these is app.15-16%.somebody on this site a lot smarter than i should give a weekly figure.the loss of weight & measure of goods bought should also be counted.not only are you paying more but also getting less.

2008 Aug 22 10:17 AM

[notsosmart:]

re above-health,housing.t... of 5.

2008 Aug 22 10:19 AM

[sieraromero:]

If anybody believes the government and business about rates of inflation and the lack of the seriousness of the problem, than they probably think that the budget deficit is NOT a problem. The whole system is a system of lies and deciet with the soul purpose of just to keep it going as long as possible in the short term and to hell with the long term consequences that will be payed for by our future generations.

2008 Aug 22 10:40 AM

[Aaron Krowne:]

notsosmart has an important point.

Also this article fails to really treat the subject on the vanguard of the debate because it doesn't mention the Shadow Government Statistics version, which had diverged to an extreme degree since the 1980 version (shadowstats.com), not the relatively minor difference Mark shows above. I think what he is missing is that the true "old" CPI is not just the previous one before this CPI-U-RS silliness; it is what was in place before the bizarre geometric-weighting and hedonic adjustments made in the 80s and 90s.

I've also studied the CPI a bit myself and find the weighting of health care expenses to be laughably low, by something like a factor of 3, at least.

I think the reason for the disconnect is that

2008 Aug 22 11:04 AM

[CLH:]

Im afraid you may be wasting your time Dr. Those who have already made up their minds and havent the foggiest what the term inflation means can not be educated.

2008 Aug 22 12:06 PM

[Gary Meade:]

I want to give you credit for your reasoning process, even if it is skewed. Inflation that I feel does not pass the stink test when compared to the government figures. I am a big picture guy...you know inductive...you seem to be lost in the details and perhaps following a path blindly because you cannot see the forest...just a thought that is original and not copied from somebody else.

2008 Aug 22 04:00 PM

[Steven Hansen:]

i am going to repeat a previous post i have made - the cpi is very inaccurate on the short haul, but seems okay when you compare say a 10 year period.

Dr. Perry, there is nothing wrong (and to me very educational) with what you have presented. but the average american is spending 10% or more today than they did a year ago - or they have cut their household expenditures by 10% to make ends meet. it is obvious to the average wage earner inflation is in double digits.

a short term index centered on food, clothing, and energy should be issued. the cost of shelter is fixed in the short haul for 99% of the people. the rest of the index is unnecessary as it can be classified as discretionary purchases.

2008 Aug 22 08:36 PM

[mouse:]

This article is so full of bull it would make great hamburgers. The published CPI numbers are so far off that they don't even begin to match reality. PLEASE go look at the REAL CPI numbers on shadowstats.com by John Williams--and read Kevin Phillips' great article about the origins of the deceptions in HARPERS' magazine a couple of months ago. And there is no such thing as "core" inflation in the real world---everybody needs to eat and use energy every month, no matter what the government says. It's just another "adjustment" to make embarrasing numbers look better. Reality will eventually have its way, and the American people may someday finally realize that they've been had by the self-serving crooks in Washington.

2008 Aug 23 06:05 PM