Inflation for you, but not for me

by Dave Munger

Whenever I call my stepbrother Mark, one of his persistent complaints is how prices are going up. "Everything costs more," he tells me. Yet for the past two years, he's received no increase in his Social Security Disability check. His money, which never went very far, now barely seems to be enough to get by. But when I read about inflation in the media, a very different picture emerges. Kevin Drum says inflation is the lowest ever. Paul Krugman says that worries about inflation are misplaced. What's wrong with this picture? Could Mark have a mistaken impression of what things really cost?

I decided to take a closer look at how inflation figures are actually derived, to see if the numbers are painting a misleading picture of what real people pay for the goods they need to survive. Inflation in the US is tracked by the Bureau of Labor Statistics (BLS), which has a very informative web site explaining exactly how they arrive at their figures. Prices are tracked by looking at a typical "basket" of goods and services people buy, currently set at a value of $100 in 1983 dollars. This is the Consumer Price Index, or CPI, which is used, among other things, to determine the annual increase in Social Security payments. The most recent BLS figures put the CPI at about 220. So the stuff that cost $100 to buy in 1983 now runs you $220. That's the basic idea, anyways.

In practice, my purchases, like those of most people, are a lot different from what they were in 1983. I'm not buying a lot of vinyl LPs any more, and my budget for skinny pink ties has significantly diminished. In 1983, I didn't have a cell phone or internet service bill, and instead of buying iPad apps, I was pumping quarters into Donkey Kong and Q-Bert. How does the BLS account for all that?

In fact, they do a pretty good job of it. While in the early years of the CPI, the proportions of goods in the "basket" of purchases they measured were changed infrequently, this has gradually improved. Since 2002, the BLS has been adjusting these weightings twice a year, based on an annual Consumer Expenditure Survey. They look at how people actually distribute their expenditures—fewer skinny ties, more cell phone bills—and incorporate that into their measure.

How do they check prices? BLS workers go into stores across the country and price a sampling of items each month. It would be impractical to price every single item in the store, so they carefully generate a random sample, then change 25 percent of their sampling each year. The BLS actually prices over 85,000 individual items each month. It's complicated: They have to have procedures for handling coupons, purchasing club discounts, free samples, and product lines that get added or dropped from store inventories.

But doesn't a basket of goods and services also vary depending on the individual? Surely Donald Trump spends much more on limos and hair care than I do, and I spend more on running gear and high-tech gadgets than Mark does (Mark has a debilitating spine condition that makes it difficult for him to walk, let alone run). Trump might be unhappy if the price of luxury yachts or casino supplies suddenly went through the roof, but those changes would barely be noticed by me and Mark. Similarly, a ten-percent increase in natural gas prices wouldn't affect me nearly as much as it affects Mark, who spends a much larger portion of his income heating his home than I do.

So even though inflation has been relatively low over the past few years, isn't it possible that the prices that have increased are ones that disproportionately affect people like Mark? Researchers affiliated with the BLS have actually made some attempts to create different indexes for different populations, but they've been unimpressed with the results.

In 1996, three BLS economists led by Thesia Gardner conducted a brief investigation of how prices for items purchased by poor people compared to aggregate prices. Examining data from 1982 to 1984, they found that poor people tend to spend more of their money on food and housing than the population as a whole. Mark's experience matches the researchers' findings quite well; he has spent as much as 80 percent of his income on housing alone. The researchers looked at how those prices changed from 1984 to 1994, and found that food and housing prices behaved about the same as other products, and thus, if anything, poor people experienced slightly less inflation than the general population. They concluded that there was no need to track inflation for the poor separately from the rest of the population.

So that's all there is to it, right? Whatever Mark thinks he's experiencing doesn't seem to be reflected in the actual data, does it?

Not so fast.

In 2003, Bart Hobijn and and David Lagakos of the New York Fed conducted a new study, this time focusing on the elderly instead of the poor. Their methods were similar: compare the spending patterns of the elderly to those of the general population, then see if the resulting inflation rate was different. Their dataset extended all the way to 2001, and what they found is that in many years, the CPI for elderly increased significantly faster than it did for the general population. In fact, if Social Security benefits had been adjusted according to the CPI for elderly, the average Social Security recipient would have received over $400 more per year in 2001 than they did under the existing system, which adjusts benefits each year based on the CPI for the general population.

What's the reason for the difference? Primarily medical costs. While the CPI for all goods and services is currently about 220, the CPI for medical care is over 393. That means prices for medical care have nearly quadrupled since 1983, while other costs have merely doubled.

At age 45, Mark isn't technically a senior citizen, but his purchases look a lot more like those of the elderly than they do the typical poor person's. Because of his medical condition, he spends much more of his income on medical care than most people do. As just one example, he recently needed to buy $400 shoe inserts to alleviate pain from arthritis. These, like many of his medical expenses, aren't covered by Medicare, and their prices are going nowhere but up. Recently one of his molars broke nearly in half, but he doesn't have dental coverage, and paying for a dentist was out of the question, so he simply ignored it.

I don't doubt that the BLS is doing everything it can to measure prices accurately, but because every individual's situation is unique, trying to assign a single number to show how all prices are rising is almost certainly going to leave some people behind. Even though the 1996 Gardner et al. study didn't show a different CPI for poor people than others, that's no assurance that prices for the poor won't increase faster in the future. The BLS should continue to monitor the CPI for the poor to make sure they are receiving adequate benefits now and in the future. The CPI isn't just a number, it's the means by which our government makes life-and-death decisions that affect millions.