Inflation Is Less Than You Think (Unless You're An Economist)

Includes: DIA, QQQ, SPY
by: Bill Conerly

What's inflation right now? The public thinks it's about three percent, but the Federal Reserve sees just 1.1 percent. It turns out, measurement of inflation is a messy topic, but the bottom line is that the public is just plain wrong.

The problem is probably that average people don't put the proper weights to the prices they see. Take a look at the accompanying chart, which shows the weights that the government uses to calculate the Consumer Price Index. These weights are derived from surveys of consumer expenditures. No one family may match these weights exactly, but they are the best idea that we have of how real people spend their money.

Notice that gasoline is about five percent of total spending. It turns out that gas is really big in consumer minds. First, we buy it every week, plus or minus a few days, so it's always top of mind. Second, the price varies from gas station to gas station, so we keep an eye on price as we drive by. We do this a lot more than we do the price of frozen pizza or t-shirts or trash bags. Third, the price varies a lot over time and can trigger unpleasant surprises.

Contrast gasoline with the cost of shelter, both rental and owner-occupied. (For homeowners, the government says that you rent your home to yourself, and inflation is based on what it would cost to rent your home.) Shelter cost changes are not obvious, especially to homeowners, but they are far more influential on total inflation than is gasoline.

We humans evolved in a dangerous world. Thousands of years ago, some people heard a rustling in the bush and feared lions or tigers or snakes. Others heard the same rustling and said, "It's just the wind." Those folks who said "It's just the wind" are not our ancestors, because they were eaten by lions or tigers or snakes. We are all descended from the survivors, those early hominids who feared bad news everywhere they went. It's been useful surviving in a hostile environment, but it leads us to focus on the bad- such as gasoline prices- rather than the good all around us.