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YOU DECIDE: Is real inflation being hidden?

May 16, 2008

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

Dr. Mike Walden
Media representatives: For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.

Eggs up 30 percent, milk up 16 percent, cheese up 14 percent and gas up a zillion percent (actually 26 percent). These are the price increases consumers have seen for many common products over the past year. Yet many economists and government officials say not to worry, because inflation really isn't that big of a deal!

"What," you're probably shouting right now. "How can inflation not be a problem with these kinds of price jumps? Are economists looking at numbers different than those on the street? Is there a disconnect between the academic and statistical worlds and the real world?"

OK, first, what do the statistics say? For all the products and services followed by the official government inflation measure, prices - on average - are up 3.9 percent over the past year. Granted this is higher than the 1.5 to 2.5 percent annual increases enjoyed for most of this decade, but it's a far cry from the double-digit inflation rates of the late 1970s and early 1980s.

Also, rapid inflation has been largely confined to two areas - food and fuel. Stripping out those two areas, inflation in the last year is only running at a 2.3 percent rate. Economists and others who claim inflation isn't a problem often cite this number.

So is there something wrong with consumers' perception of inflation that makes them overstate the actual rate? Or is there something amiss with the official measure of inflation that makes it understate what's really happening with prices?

Let's look at the second question first, how inflation is measured. Every month the federal government collects prices for hundreds of consumer products and services sold in over 20,000 stores. The prices are then averaged to form an overall price index. But - and this is very important - each price isn't counted equally in the average. Instead, the prices are weighted based on their relative importance to the average household's budget.

This means prices of items we spend more on get a bigger weight in the average, and prices of items we spend less on get a smaller weight in the average.

And herein lies one explanation for the apparent discrepancy between what consumers think the inflation rate is and what the official numbers show. For the food items mentioned in the first paragraph, eggs account for only one-tenth of one percent of consumer spending, and milk and cheese each account for only three-tenths of one percent. Indeed, all of food - including what we use at home and what we buy from restaurants - makes up only 14 percent of consumer spending.

But perhaps the real shocker is gasoline. For all the attention it receives, gasoline takes only 6.5 percent of the average consumer's spending. This is less, by far, than what we spend on shelter and about the same as our spending on medical care, on education and on fun (recreation).

Consumer perceptions are also part of the issue. It's human nature to focus on negative, or problem, areas of our lives and perhaps overlook the positive. So when tracking prices, we remember the prices that have gone up and ignore or forget the prices that have dropped.

So while rises in food and gas prices have received all the attention, unnoticed is the fact that many prices have been falling. Included in this category are prices of furniture, appliances, tools and hardware, clothing, TVs and computers.

Now I know what some of you are thinking: These average numbers (like 6.5 percent of consumer spending for gas) don't fit me. And for many people, this is absolutely true. An average is just that - an average. Many people spend much more than 6.5 percent of their budget on gas, but many people also spend less. At the same time, there are numerous folks who spend more than average on furniture, clothing, TVs and computers, and these people have all gotten price deals in the last year.

So what's my point? It is that reality can be tricky. What gets hyped and what we remember may not be the whole story, and a good example of this is today's price inflation. But does this make you feel better? Well, you'll have to decide!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ncsu.edu/waldenradio/

Posted by Dave at May 16, 2008 08:00 AM