Personal finance blogger Financial Samurai noticed the traditional CPI-based approach to determining inflation may not be accurate.

"See this latest price change chart for various consumer goods and services. Unless you plan not to go to college, not have kids, not get sick, not eat, and not live under a roof, you are feeling inflation at work. At least we can buy all the TVs, software, and toys we want!"

What Is The Consumer Price Index (CPI)?

The CPI is calculated by the Bureau of Labor Statistics and is the weighted average of prices in a basket of consumer goods and services, such as food & beverages, housing, education, and medical care. Think of the CPI as a measure of the cost of living. It's a number that's incredibly complicated to calculate. Hundreds of federal employees have to go to stores all over the country - every month! - and price thousands of different things.

The Federal Reserve Board, Congress, and the president monitor changes in the CPI to determine whether the US economy is going through a period of inflation or deflation. Armed with this information they can formulate fiscal and monetary policies to aid the economy. The Federal Reserve's goal is to maintain a 2% rate of inflation and that goal has been achieved with some consistency since the mid-90s.

Pardon Me While I Put On A Tinfoil Hat

Run a Google search and you'll find plenty of people questioning the accuracy of the CPI and inflation. That's because certain variables in the calculation have seen dramatic increases in price over time. Check out the graph above and you'll see what I mean. Consumer goods and services such as textbooks, college tuition, childcare, and medical care have seen significant price increases since the mid-90s. While we know which goods and services are price-checked to determine the CPI, the weightings of those goods and services is a secret. There's a reason for the secrecy: People could probably make some serious money if they could figure out the CPI before the numbers are released.

Would the government underreport or manipulate the CPI? I can think of at least two reasons why they might:

  1. The desire for social and economic stability. Obviously, this is important. Keeping the economy running smoothly ensures stock markets perform well, unemployment remains low, and prices for good and services are held at reasonable levels.
  2. Low CPI = Low(er) government spending. The higher the CPI, the more the government has to spend on income payments to, among other things, Social Security beneficiaries and food stamp recipients.

While the CPI may be manipulated to some degree, I honestly don't believe there's a nefarious group working to control society. I'll leave the conspiracy theories to the writers of entertaining TV shows like Mr. Robot.

Okay, tinfoil hat removed.

The Takeaways

I'll break this down into three important points:

  1. Consumers need to remember that inflation estimates from the government may not be entirely accurate. Anyone who regularly pays for food, housing, medical care, or childcare knows this because prices on these items have outpaced the Fed's target inflation rate.
  2. Even with higher-than-stated inflation, you have control over what and where you consume goods and services. Let's use food as an example. Everyone needs to eat, so there's no way to avoid higher prices for food. However, we can choose where we buy food. Buying groceries from Whole Foods will almost certainly cost more than shopping at Giant or Safeway.
  3. Financial planners should review the inflation assumptions used when developing plans for their clients. The planning tools I've worked with have always provided the option of using either a default inflation assumption or one set by the user. My fellow planners: Be sure to check your settings!

Would You Like To Know More?

NPR's Planet Money Episode 222: The Price of Lettuce in Brooklynprovides a great lesson on the CPI and how it's calculated. The segment is 14 minutes and 27 seconds long.

Listening / Reading / Watching

Here's what's got my attention this week:

  • Framed: A Mystery in Six Parts by Christopher Goffard of the L.A. TimesA PTA mom and afterschool volunteer. A power couple, both lawyers. Accusations of verbal and physical abuse to a child. Drugs found in a car, most likely planted by the lawyers. This is a fascinating story about a petty fight that gets out of control.
  • Paradigm Shifts, Parts 1 through 4 by Alex Danco of Social+Capital. This is a lengthy, but worthwhile read about how technology is changing our world. As a big fan of Tesla, I found part four especially interesting.