Chains and Baskets

A pound of whole-wheat bread today will run around $1.91; it cost $1.79 a year ago; and in 2001 the same loaf (all numbers are for May and all from the Bureau of Labor Statistics) ran $1.47. The first of those numbers was worth $0.14 in 1929—and would presumably also get you a loaf of bread. Welcome to inflation.

My subject today is how easy it is to track actual prices if you make the effort to collect them regularly, as the Consumer Price Index people do—and how complicated it gets to sum up all these numbers into a single CPI number by means of which we compare our current purchasing power to that of distant years—the marvel that in 1929 fourteen pennies bought us a loaf of bread, but in 2011 it too nearly 14 times more.

The BLS’s metaphor for this is to talk of a market basket of a curious kind. Everything goes into it, not just food and clothing but also such things as housing, medical care, transportation, education, communications, recreation, and everything else that we spend our money on. How exactly does the BLS determine what that shopping basket should contain?

It turns out that the market basket is defined by sampling. It involves 7,000 families who report every quarter on their spending habits. In addition, another 7,000 families maintain detailed diaries recording everything that they spent money on for a two-week period. All told, the shape and meaning of the market basket emerges every two years from 28,000 weekly diaries and 60,000 survey interviews. The diaries kept by these families provide the most important element of information of all, the relative weight that individual products or group of products should have in the determination of a single monthly CPI number. The families, of course, will report on food purchases, and in detail—as well as on their house payments or rents. Suppose food prices went up 5 percent but housing costs by only 1 percent. Which of these expenditures should be viewed as more important. The rules say that the more you spend, the more important that thing is. Therefore food will be less important than housing. Here, for instance, are the weights assigned to eight major categories in two different periods.

These weights come from those diaries. The 2005 values were applied in 2008 and subsequent years. The 2007-2008 values were applied in 2010 and subsequently. Here we note that some categories “lost” and others “gained” weight. Food lost some of its weight, therefore increases in food prices were reflected less and increases in recreational expenditures (the biggest upward change in weight) reflected more of their changes in the CPIs that used this kind of weighting. In other words, that loaf of bread at $1.91 reflected its 6.7 percent increase in price only partially. Only 14.91 percent of it (thus .999) actually managed to become part of the CPI.

Now, mind you, these are weights for aggregates. Transportation, for example, includes new vehicles, airline fares, gasoline, and auto insurance. Transportation dropped in “weight” in these two periods. Why? One would have to see the details. Did people buy fewer cars? Travel less by air? Did that more than match increases in gasoline prices? The devil is in the details. The basket contains more than 200 items—tangible like food and intangible like insurance payments. Each of these items has its own weight, and it is the aggregation of them that produces the category weights. Further, these are the weights used for Urban Wage Earners, and other categories are also collected separately and the later merged. Therefore things get complicated.

The actual job of obtaining the prices associated with the items in the basket is accomplished by in actual pricing-surveys conducted by the BLS itself.

Yesterday I mentioned a special deflationary index, the chained-dollar index used by the Bureau of Economic Analysis to express the value of Gross Domestic Product in constant dollars. It differs from the CPI in using the average of two successive periods (quarters, in this case), combining their weights and price increases, to give results for the current period. Of these two, lets call them a and b for the index to be used in Quarter A, b will be combined with c and averaged to produce the next chained index in Quarter B.

Chained, ah, baskets seem to be a little more representative of real change than just baskets with their weights changed every now and then, say at two-year intervals, rather than quarterly, with two quarters’ results averaged or smoothed out.

Seven thousand people keeping diaries in the midst of life’s hurly-burly. Then mountainous computer work and 60,000 interviews just to define the basket. Finally, after the actual price survey, comes the precious number or its chained cousin. But by the time the number hits the news, it has the sound of Gospel.

Eat the Core, Never Mind the Apple

A very bad habit began in early 2000. In February of that year the Federal Reserve Bank, then under Alan Greenspan, abandoned the Consumer Price Index (CPI), produced by the Bureau of Labor Statistics, as the basis for measuring inflation in the economy. Instead it substituted the Personal Consumption Expenditures index, produced by the Bureau of Economic Analysis. Now, mind you, the PCE is based on the CPI. It’s not a free-standing anything. No CPI, no PCE either. But the PCE modifies the results of the CPI by using a somewhat different formula. Underlying it is an assumption that when prices go up people will shift their purchasing to another product. Now the PCE comes in two varieties: the total PCE and then the so-called core PCE. The core excludes food and energy—these two being viewed as volatile and seasonal.

Let’s think about this. Food prices are rising. Now, based on PCE thinking, I’m going to substitute some other purchase for my purchases of food. Right? Obvious, isn’t it? I’ll go on vacation and not eat at all. Or, alternatively, gas prices are rising. Economic rationalist that I am, a true believer in the PCE, I will therefore stop driving. My thirty-mile commute can be accomplished on a bicycle, of course. And just imagine the health care benefits!

Or better yet! CPI is rising. But so, alas, is PCE. But I am a Federal Reserve Banker. When the economy goes south, I feel a lot of heat on my backside. So why don’t I give up both? I’ll give up both food and energy purchases. I’ll just live on the core of the apple. I didn’t like all that sweet moist stuff anyway—juices always dripping down and messing up my striped-blue suit. Thank the Lord there is the core PCE. I can not only use it in all of my measurements but above all in every one of my public statements.

Now here’s an added complication. The PCE is published quarterly, the CPI monthly. And since the PCE reflects the CPI (indeed can’t exist without it) everybody and his brother still uses the CPI to talk about inflation. They just exclude two categories from it. They exclude food and energy. That leaves the core, doesn’t it. And thus we get the phrase, “core inflation.” Now, best of all, CPI is rising, but the core of it isn’t, or only faintly. Thus those of us who feel the heat from the public can pronounce that all is well. The core’s in good shape—even if the apple’s rotting.

The graphic you see puts all this into a picture. I show monthly changes in CPI by three categories since July of 2010. Whatever prices were in July, that’s what they were. I call that 100. The bars show changes in price from that level. Lo and behold. Food prices are up 1.9 percent in this seven-month period, energy prices up a whopping 14.8 percent, and the rest—that’s the core, folks—is up less than 1 percent (0.7% actually). The data I am using may be found here.

Food and energy are the apple. The rest is what, in a real pinch, we can mostly do without. But our leaders are wise. They know that we will believe what they say, not what they do.

How Old Is the CPI?

Looking at the latest press release on the CPI numbers, issued by the Bureau of Labor Statistics (BLS), the idle thought occurred: I wonder how old the CPI actually is? My guess was that it arose, no doubt, either in connection with World War II or in the wake of the Great Depression. I expected the usual quick answer from either the BLS itself or from Wikipedia. No quick answer anywhere. But—finally!— I did find the answer—and it surprised me. I discovered it in The First Hundred Years of the Bureau of Labor Statistics, a 321 page history but issued as Bulletin 2235 by the BLS. It appeared in September 1985 and was written by Joseph P. Goldberg and William T. Moye. The book is available on the web here. I found the relevant event I was after recorded in this paragraph spanning pages 34 and 35:

Two reports prepared by the Bureau for the Aldrich Committee became landmark sources of data on prices and wages. Some wholesale price data were assembled for the preceding half century; for the 28-months preceding September 1891, prices were collected for 218 articles in 7 cities. Retail price collection was limited to the 28-month period, covering 215 commodities, including 67 food items, in 70 localities. Wage data were also assembled for the preceding half century in 22 industries; for the 28-month period, the data covered 20 general occupations in 70 localities and specialized occupations in 32 localities.

The Aldrich Committee was the Senate’s Committee on Finance, chaired by Nelson W. Aldrich on Rhode Island. The Tariff Act of 1890 had been passed. It’s known as the McKinley Act named after then Congressman (later President) William McKinley. (Full disclosure: Quite appropriately for a data maven like me, I live on McKinley Avenue). The McKinley Act was my kind of law. As Wikipedia summarizes it “The tariff raised the average duty on imports to almost fifty percent, an act designed to protect domestic industries from foreign competition.” Hear, hear! Anyway, Senator Aldrich asked the Bureau of Labor Statistics, at that time a mere six-year-old, to collect the right kind of data in order to measure the effectiveness of the McKinley Act.

The fundamental methodologies and ideas behind the Consumer Price Index now in force were already in place 120 years ago. The BLS defines a kind of “representative basket of goods and services”; it sends its agents out to visit actual stores and other institutions to collect current pricing data; and it does so across the country. Mind you. “Basket” here means more than just groceries and clothing. It includes all categories of consumer spending including fuels, rents, mortgage payments, premiums, tuitions, fees, childcare—and, yes, money spent on all kinds of products including groceries and clothing.

The idea of weighting each category within the price indexes—in order to derive a single representative number that stands for prices in general—was already present in 1891. The idea was introduced by Ronald P. Falkner, of the University of Pennsylvania, who had been hired to analyze the data the BLS had collected. Weighting was based on patterns of family expenditures. Thus categories were ranked by the amount of  money families actually spent on them. The greater the spending, the higher the weight. The name of the CPI was initially Cost-of-Living Index. The renaming took place in 1945 and was then called Consumer’s Price Index for Moderate Income Families in Large Cities. Today we call that series CPI for All Urban Consumers (CPI-U). Using the CPI as an official measure to adjust wages, pensions, and so on dates back to 1948.

Having now stared for a while into the well of the past, I will proceed to present the February 2011 numbers.