Phipps: Concluding the "Ag Splainer" on Inflation

January 3, 2017 10:48 AM

Time for our thrilling conclusion to our “ag splainer” about inflation. Last time we looked at the two major tools to measure inflation the CPI and PCE. We saw how they were a basket of consumer expenses and price changes for each component were weighted to reflect how Americans spend money.

But just like the average farm, there is no average American.

Here is the CPI basket. But for example, if you are a young family your basket could look like this: a higher portion of your budget going to food, shelter, and transportation and less to medical and education - we'll assume they don't have kids in college yet.

Compare this with seniors. They typically spend proportionately more on food simply because their budget is smaller and they don't have other expenses. They spend much less on apparel, housing, transportation, and education, but way more on medical. All families have their own inflation basket, and this is where the arguments begin.

This chart shows how different parts of the basket have increased in price. The 100 line is an index showing the average CPI for the period. Expenses above 100 are increasing faster than general inflation and vice-versa. Three things stand out. Education - which is almost all higher education - is by far the fastest inflating sector. Next highest is medical care, followed by shelter.

To the extent your budget includes more of these three components than average, your personal inflation rate will likely be higher than the headlines. This is why people are skeptical of inflation measures and may think the figure is manipulated. Also note that if you are healthy, have your home paid for, and aren't paying for college, inflation has not been a problem for you and could even be negative with goods and services barely increasing in price. Think about big TV prices, for example.

So when you see this chart of inflation since 2000, the most important thing is to notice how remarkably stable prices have been for really long time. Inflation under two percent means your purchasing power in not eroding very fast, unlike the experiences of the 80's.

But the old disclaimer applies: your results may vary. Whether this trend for low inflation continues is anybody's guess, but predictions of higher inflation have been so wrong for so long, economists are beginning to question if we really know what causes general price increases. Most expenses, like food and clothing have been relative bargains; college; health care and housing drive the inflation trend.

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