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What's the Real Inflation Rate?
by   Mark Wade  

It seems like every day when we go out to buy something, we’re confronted with the corrosive effects of inflation. The average price of a gallon of gasoline in New Jersey, despite a recent leveling off, is still up by $1.10 over a year ago, an increase of 43 percent. The price of ground chuck is up 14 percent in the past year for the Northeast region, and the price of bacon up 29 percent as of April (at this writing, the most recent month for which we have figures). And in late May, Starbucks announced that it was raising the price of its packaged coffees by 17 percent. No matter what you’re buying this morning, it seems like it costs more than it used to.

But at the same time, the federal government officially reports the inflation rate for the Consumer Price Index at 3.2 percent for the 12 months that ended in April. And the core CPI – which strips out food and gas prices, supposedly because they’re inherently volatile - is even lower than that, at an annual rate of just 1.2 percent. How can that be?

Some people have noticed the incongruity of this. A writer named Niall Ferguson argued in Newsweek last month that the only reason the official inflation rate is so low is because the government keeps changing the way it calculates that statistic. “The way inflation is calculated by the Bureau of Labor Statistics has been ‘improved’ 24 times since 1978,” Ferguson writes. “If the old methods were still used, the CPI would actually be 10 percent.”

What Ferguson fails to note is why the BLS has made those changes. American spending habits have changed dramatically since 1978. The BLS continuously surveys American households to determine what people are buying, and adjusts its inflation measures accordingly. In 1978, the typical American spent 13.4 percent of his or her disposable income on food, and 9.2 percent on food that was prepared and eaten at home. By 2008, those numbers had fallen to 9.6 percent for all food, and 5.6 percent for home-prepared food.

So the percent of our income we spend at the grocery store has dropped from 9.2 percent to 5.6 percent in 30 years. Naturally, the BLS has adjusted its estimates for that kind of thing. What are we buying in its place? Electronics, for one thing: We didn’t have smart phones, flat-screen TVs or iPads back in 1978, but people buy plenty of them now, and their prices have been falling. The price of flat-screen TVs, for instance, has declined by about a third over the past year.

The prices of other big-ticket items have also shown little evidence of inflation lately. Apparel, for instance, has been flat, showing a price increase of just 0.07 percent over the past year. And of course, housing prices have been stuck in mud for a good five years now: Since the market peaked in June 2006, home prices in the New York metropolitan area, which includes northern and central New Jersey, have dropped by 24.2 percent. Even in the past year, they’ve dropped in additional 3.4 percent. That kind of thing makes a huge difference in the official figures, because housing costs account for 42 percent of the BLS core inflation rate.

The pattern seems to be that the sort of very expensive items you buy infrequently have seen their prices remain moderate. Meanwhile, the smaller-cost but everyday items have been the ones to see their prices go up the most. While the everyday costs are much more visible, they have been balanced to some extent by the larger items.

The upshot is that the official inflation rate has been able to stay at historically low levels. Until the recession brought it down below zero in 2009, the inflation rate had remained between 1.5 percent and 4.0 percent for the entire decade of the 2000s. The current official rate of 3.2 percent, then, is historically normal.

So what is the “real” inflation rate? The answer to that lies in your spending habits. The effects of inflation will be much stronger on a retired couple who plan to spend the summer driving around the country in an RV than they will be for a 26-year-old single guy who spends half his income on the latest electronic gadgets.

Of course, the inflation rate affects more than just your trips to the grocery store; it affects your overall financial goals as well. To learn more about how Echelon Wealth Strategies can help protect your assets against inflation, feel free to give me a call at 908-647-6000.


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