ron paul

Photo: AP

Ron Paul put on a show at Fed Chairman Ben Bernanke’s testimony on monetary policy earlier today—even challenging the Fed to let him pay his taxes in gold.In his rant, Paul argued that inflation was actually more like 9 per cent—and not the 2.9 per cent increase that Bureau of labour Statistics says we’ve seen in the last 12 months—based on the old CPI statistics.

This “old measure” of measuring consumer prices actually touches on a much larger debate–one that has been spearheaded by John Williams and his website Shadow Government Statistics. Ron Paul endorsed Shadow Stats statistics in an interview with Fox Business last year.

The stats

Williams’s research contends that the 12-month inflation statistic we should have seen last month was 10.5 per cent, arguing that the basis for calculating CPI back in 1980 was the pure formula before “the reporting system increasingly succumbed to pressures from miscreant politicians, who were and are intent upon stealing income from social security recipients, without ever taking the issue of reduced entitlement payments before the public or Congress for approval.”

(Williams also contests other government economic indicators, like M3 money supply, one of the keys supporting Ron Paul’s argument that expansion of the money supply produces an almost 1-to-1 increase in inflation.)

From the BLS (.pdf), these are the three main pieces of their CPI calculations that regularly come under attack from Williams and his ilk:

  • Beginning in 1983, the BLS changed the way it saw homeownership from reflecting the price of the asset to reflecting its rental equivalence.
  • Beginning in 1998, the BLS expanded the list of consumer goods on which it performs hedonic regressions to include computers, televisions, and refrigerators. Such regressions attempt to control for changes in the quality of goods.
  • In January 1999, the BLS changed the way it calculated indexes to reflect consumers ability to switch to, say, cheaper apples sold in the same market when other apples became more expensive. That’s a change from the Laspeyres index used to calculate CPI before then.

The main issue

Critics of the BLS take the biggest issue with the final item here. We’ll synopsize briefly an illustration of the Bureau gives as to why it made this change:

You generally buy four candy bars—two peanut and two chocolate bars—at $1 a piece. The price of the peanut bars goes to $4. So in order to buy exactly the same goods, you’d have to spend $10. So the Laspeyres formula would say that the price of your basket of candy goods increased from $4 to $10.

The BLS argues that because consumers maximise their utility with respect to prices, they shift away from more expensive goods when very similar goods are cheaper—and they wanted to account for this in their measurements. So maybe paying $7 for one peanut bar and three chocolate bars gives you the same utility as your initial purchase. Thus, saying that $10 is your new price of goods would be an “overstatement” of what’s actually happening—they’re not arguing that your utility is exactly the same for $4, they’re arguing that $7 is a much more realistic evaluation.

Taken at face value, the problem is readily apparent—it would appear that the BLS wants you to scrimp on steak, eat more hamburger, and deal with it. See Williams’s argument:

…it is the so-called “overstatement” in the cost of living that enables the maintenance of a constant standard of living, where the consumer does not have to be concerned with changes in price. The BLS claims that with the geometric weighting, weighting shifts are measuring a “constant level of satisfaction,” that there is no “declining standard of living” in the numbers, because geometric weighting is not applied to broad enough categories to allow hamburger substitution for steak.

While this argument may appear to be persuasive, it ignores one simple fact: the consumer price index is meant to measure the effect prices have on a consumer’s utility, not what they can actually buy. Paying $7 gets you more utility than paying $10 (because you have $3 more dollars left over), so obviously you’re going to adjust your purchasing accordingly.

To give an even more real-world example, if I’m having people over for dinner, I’m going to hem and haw over buying yellow bell peppers because on one hand it makes my stir-fry look more appetizing, but on the other hand buying the same number of green bell peppers puts another $1 in my pocket. Since both choices provide me equal utility, it only makes sense for the BLS to evaluate them equally.

Now, considering that the price of yellow peppers ($3) is always higher than the price of green ($2), if the price of the yellow peppers were to rise ($4), then the BLS would account for the fact that more consumers are going to switch to green peppers as an alternative to yellow peppers because they’d rather have the utility of extra cash in their pockets. Thus, there will be a jump in the price basket, but it’s mitigated by the fact that consumers are retaining some utility out of saving the money.

If the inflation rate measures the change in the purchasing power of your dollar, then CPI is clearly meant to assess the amount of money you would need to produce the same amount of utility, not purchase the exact same goods. Thus Williams’s point—while seductive—just doesn’t add up.

ron paul

What does make some sense

On one point, however, Williams’s critique sounds vaguely legitimate.

There are some indications that the BLS has conformed to certain political biases in the past. On his website, he even points out various reliable reports where statisticians may have had meaningful political motivations to make alterations to the bundle of goods in the CPI basket for funding reasons.

He argues that politically-motivated alterations were made to lower the value of CPI when the BLS included new items in its basket of goods starting in 1998:

Quality adjustments of the hedonic, more-theoretical kind, however, have tended to reduce reported inflation meaningfully.  In the article the BLS indicated that hedonic adjustments had increased prices in certain products. Those “increases,” though, often were based on comparisons against prices that already had been previously adjusted and reduced based on simpler quality assessments.

There may be some reasons to believe this is the case and even some reason to believe that the government has tampered with some of its statistics.

All that being said… the very example that Williams gives as to why these hedonic adjustments are so insidious just proves how trivial and out-of-proportion the impact of these changes has been. Read his argument:

Getting more into the hedonics area, I’ll get personal. I use two personal computer systems purchased about 10 years apart for roughly the same price in nominal terms, about $800. While the most recent computer has greater memory and is faster than my old system, both systems generally perform the same tasks for me. Based on the BLS’s adjustments to computer prices, in terms of quality/hedonics, my old system should have been replaceable for about $85.00 in current dollars, which was not doable. I do have a nicer picture screen, with the new system, but I also unexpectedly had to buy a new printer, because the new system was not able to function with my antique work-horse printer. The new computer also was not able to use certain key programs that had not been rewritten to the standards of the new system. How does one compare and value such systems in the CPI? While some quality adjustment in the case of computers seems appropriate, I argue it has been heavily overdone from the practical standpoint of the average consumer.

If the only things Williams’s new computer provides him with are more memory and speed, then it’s hard not to believe that he didn’t get ripped off. Operating software, hardware (I’d bet that 1998 computer didn’t write DVDs), compatibility, functionality, heck—Wifi; obviously the ’98 computer is scrap. In fact, if you look on eBay for computers built 10 years ago, a Mac G4 Desktop which initially sold for $2,299 now costs $105 on eBay.

Calculations of utility are based on average consumer choices, and if Williams wanted his new computer to do exactly the same things and didn’t care about new features aside from speed or memory, then he should have purchased as a $500 computer and spent the rest on a new printer.

 It’s still a conspiracy theory

We can clamor as much as we want about how a politician could have tried to bribe BLS officials to change the CPI system by offering the bureau money, but there is no hard evidence to prove that the BLS was motivated to change their calculations for political motives.

To boot, the data certainly don’t suggest that consumers are experiencing a 10.5% inflation rate right now, no matter how difficult it is for consumers to cope with the inflation they are seeing. From economist Doug Short, who acknowledges that Williams’s argument about a government bias is “thoughtful”:

The more I study inflation the more convinced I am that the current BLS method of calculating inflation is reasonably sound. As a first-wave Boomer who raised a family during the double-digit inflation years of the 1970s and early 1980s, I see nothing today that is remotely like the inflation we endured at that time. Moreover, government policy, the Federal Funds Rate, interest rates in general and decades of major business decisions have been fundamentally driven by the official BLS inflation data, not the alternate CPI. For this reason I view the alternate inflation data as an interesting but ultimately useless statistical series.

And that’s why they call it a conspiracy theory.

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