Your Personal Rate of Inflation is Higher than the Official CPI Numbers
So you’ve noticed your grocery bill, restaurant bill, family vacations, home appliances, gasoline, and even stocks have all become significantly more expensive than the official Consumer Price Index (CPI) numbers would indicate. Even if your wage increases have kept up with CPI inflation numbers you may be feeling like you just can’t keep up with all the price increases. The good news is you’re definitely not alone, the bad news is that this trend will continue over the coming years. I’ll briefly explore why official CPI numbers don’t reflect your actual inflation.
Consumer Price Index (CPI) is a widely used measure of inflation that tracks the average change over time in the prices paid by consumers for a market basket of consumer goods and services, such as food, clothing, housing, and transportation. While the CPI is the most commonly cited tool for understanding general trends in prices, it does not reflect the full extent of inflation experienced by individual households or specific sectors of the economy. Several factors contribute to the reality that official CPI numbers are much lower than actual inflation experienced by the majority of households:
Substitution Effect: The CPI uses a concept known as the "substitution effect," where it assumes that consumers will substitute cheaper alternatives for goods and services that have experienced price increases. While this reflects how consumers adjust their spending, it does not capture the actual impact of price increases on specific items.
Quality Adjustments: The CPI accounts for changes in the quality of goods and services over time. If a product's quality is perceived to have improved, its price increase is attributed to quality improvements rather than inflation. This results in the CPI understating inflation.
Geographic Differences: CPI is a national index, so it does not capture variations in prices across different regions, cities, or rural areas. Individuals in areas with higher housing costs or other specific cost-of-living pressures may experience higher inflation than the CPI indicates.
Basket Composition: The CPI basket is based on average consumer spending patterns, which does not accurately represent the spending habits of every individual or household. If someone's spending differs significantly from this “basket composition,” their personal inflation rate may be higher.
Measurement Biases: Data collection methods, sampling, and statistical techniques used to calculate the CPI introduce measurement biases that affect its accuracy.
Exclusion of Asset Prices: The CPI primarily focuses on consumption goods and services and does not include asset prices like housing and stocks. Increases in asset prices, such as a housing market boom, can significantly impact household wealth and living costs but are not reflected in the CPI.
It's essential to remember that the CPI is a contrived indicator of inflation trends that is used for various economic and government policy purposes. For individual financial planning or assessing personal inflation, it's important to consider one's specific spending patterns and circumstances, as these are usually much higher than the CPI. For some alternative, and more realistic, inflation numbers that I recommend checking out the Chapwood Index and Shadow Government Statistics.
Next up I’ll be exploring tactics for keeping up with real inflation numbers so your assets don’t lose value over time.