A Flawed CPI?

As we were talking about today, CPI is the general statistic used in the United States to measure inflation. But it is often criticized for its limiations. The following article really does a good job of summarizing this argument from a consumers perspective...

Be sure to look for questions at the end.

Why Inflation Seems To Have Sharper Teeth Than the CPI Suggests
David Wessel. Wall Street Journal. (Eastern edition). New York, N.Y.: Mar 16, 2006. pg. A.2

WRITE ABOUT inflation, and readers are quick to complain that the U.S. government's consumer-price index fails to capture the reality of rising prices."If you did your own personal study of inflation in your neighborhood . . . where you shop, you would be appalled at how much prices go up without being reported as inflation," Reggie Marselus emailed from Lenexa, Kan. "Government inflation figures are the most bogus numbers reported in the entire economic world."

The Bureau of Labor Statistics releases the latest CPI this morning. Forecasters say a drop in gasoline prices in February will keep the monthly increase in the CPI to a comfortable 0.1%, though that still is a sharp 3.7% above a year ago. Wall Street traders, private forecasters and Federal Reserve officials will scrutinize the details to divine if energy-price increases are spilling over into other items, pushing up inflation. Americans coping with rising health-insurance premiums, or paying college or private-school tuition bills, or trying to buy a house, look at those numbers and scoff. The cost of living, they often say, seems to climb a lot faster. Some economists don't much like the most commonly used version of the CPI, either. They say it overstates inflation, but that is another story.

SOME CONSUMER skepticism is inherent in the way a price index is calculated. It is an average -- and no one is average. It measures the change in prices in a basket of goods and services that matches no one person's shopping list: Medical care accounts for 4.8% of the CPI. But if you are chronically ill, you will notice rising health-care costs more. College tuition accounts for 1.1%. But if you have a child in college -- well, you get the idea. The CPI is a national average: The fine print shows that prices rose 1.7% in 2005 in the San Francisco area, but 4.8% in the Miami area.Monthly changes in the CPI, the ones that get the most media attention, are adjusted to remove usual seasonal fluctuations. "In many cases, we may talk about a component declining when it actually rose, but less than it historically did in that particular month," says Patrick Jackman, the Bureau of Labor Statistics price maven. "It doesn't make much sense to the man in the street to tell him that gasoline prices declined, when they just rose less than the seasonal pattern expects."U.S. government inflation figures also recognize that a $1,500 personal computer available today is more powerful than a $1,500 PC purchased three years ago. If it is twice as powerful but carries the same price tag, then the BLS counts that as a price cut, a decline that offsets price increases in other things. And then there is housing. To the consternation of some economists, the CPI doesn't track the rising price of houses directly, but instead relies on rents, which have been rising more slowly than house prices. The rationale: The CPI tracks the cost of living in a house, not its investment value. "Homeowners are assumed to rent to themselves at the market rent," the BLS explains. Japan does the same. Europe, in contrast, currently excludes owner-occupied houses from its pan- European price index. The mismatch between official inflation statistics and consumer perceptions reflects more than the fine points of measurement. When consumers get a good deal -- a bargain airfare on the Internet or a case of soda on special -- they think they are great shoppers. When consumers see their electric bills go up, they curse rising prices. They don't look at airfare savings as offsetting electric-bill increases. They don't notice what the CPI does: The price of men's pants has fallen more than 5% in the past year.

THAT'S NOT ALL. Consumers who complain that the government understates inflation may really be saying that their paychecks don't seem to go as far as they once did. For many Americans, that is true. But it isn't that prices are going up faster than the government estimates. It is that their wages aren't keeping pace. Blame the boss, not the BLS. Not so long ago, inflation preoccupied Americans. A check of the Factiva electronic archives -- jointly owned by Dow Jones & Co., publisher of this newspaper, and Reuters Group PLC -- found 760,288 mentions of "inflation" from 1986 through 1996 in all publications tracked, outnumbering 636,074 mentions of "sex."Then inflation receded. In the past 10 years, "sex" has been mentioned 3,317,716 times and "inflation" just 3,085,544 times. But the complaining -- about the inflation measures, that is -- never stops.

Making Sense of This...Many of you are going off to college soon. How does the described measurement of the CPI affect you? Additionally, if the CPI is this controversial (some think it overstates, others think it understates)...can you suggest a better way? What would it be and why? A quick browsing of the internet might help here!