Introduction According to John Williams, who has been tracking and poiting out the flaws and degradation of the CPI for 30 years, there has been a widening gap between government statistics of "inflation" - the CPI - and the general public's perceptions of actual "inflation". People feel that prices have been rising faster than what is officially reported. This growing difference is primarily due to changes made over decades as to how the CPI is computed. In recent decades, the keynesians have offered theoretical constructs to the methodology and definition to the CPI, which have little relevance to the public's use of the CPI. To make matters worse, these changes have not usually been communicated to the public. Moreover, run-of-the-mill folks reckon the CPI as a measure of the cost of living of maintaining a constant standard of living, in addition to measuring that cost of living in terms of out-of-pocket expenses, i.e. the actual prices they have to pay. Without meeting these criteria, the CPI has little to no use for individuals. Although the CPI used to meet those criteria, government efforts turned the CPI away from measuring the price changes in a fixed-weight basket of goods and services, to a quasi-substitution-based basket of goods, which destroyed the concept of the CPI as a measure of the cost of living of maintaining a constant standard of living. Separately, the use of hedonic quality modeling in adjusting the prices of goods and services destroyed the concept of the CPI as a measure of out-of-pocket expenses. Estimated by computer models, hedonic adjustments alter inflation accounting for nebulous quality changes that cannot otherwise be measured directly and that usually are not recognized by consumers. From standard of living to cost of living The changing costs of maintaining a constant standard of living were measured by pricing out a fixed-basket of goods and services - same components, same weighting - over periods of time. Whatever the percentage change was in the prices of that basket of goods, that is how much income would have to rise in order for someone to maintain the same standard of living over the given period. Furthermore, tracking changes in the cost of a fixed-basket of goods was the approach to estimating inflation, going back to at least the 18th century and until 1945, the fixed-basket CPI tracked by the US government actually was known as the Cost of Living Index. In the first half of the 20th century, the "constant level of satisfaction" concept mutated into the "true cost of living" concept, among keynesians. They argued that a rise in the prices of goods, instead of keeping individuals consuming whatever goods they were consuming, they would consume cheaper, substitute goods, keeping the same level of "satisfaction". Basically, a change in prices would lead consumers to change their consumption patterns in order to keep the "utility" constant. The constant-level-of-satisfaction approach was contrary to the concept of measuring the cost of maintaining a constant-standard-of-living. Maintaining a constant-standard-of-living means being able to consume the same goods in the same quantity, without having a trade-off between living quality and prices. For example being able to buy needed gasoline without having to turn to food of lower quality. Politization of the CPI In the early 1990's, Washington, DC had its mind set in changing the nature of the CPI. The contention was that the CPI overstated inflation, by not considering the substitution effect. Both sides of the aisle and the financial media advocated for a reformulated CPI, which would allow the substitution of goods and services. In a September 15 of 1995 New York Times article, Robert Hershey reported that Alan Greenspan, who was chairman of the Fed, the then chairman of the Council of Economic Advisors Michael Boskin and Republican House Speaker Newt Gingrich were touting for this reform. As Michael Boskin put it: “[E]conomists believe one of the most important [CPI upside biases] is when consumers shift their buying patterns in response to changing prices, substituting one product for another. The [CPI] index is based on a fixed market basket of goods and services. But, for example, if the price on an item like steak gets too expensive, consumers may switch to hamburger.” But why did they want to change the CPI? The reasoning is that this correction would imply lower government expenditures and, at the same time, bigger fiscal revenues. In a nutshell, the plan was to reduce cost of living adjustments for government payments to Social Security recipients and programs of that sort. The cuts in reported inflation aimed at reducing the federal deficit without any congressmen having to commit political suicide by voting against Social Security. The changes in the CPI also pushed taxpayers artificially into higher tax brackets, thus increasing tax revenues. This a rather ingenious plan. Instead of admitting to the public that the government didn't have sufficient resources to keep up with the promises it made to buy your vote, politicians made the public believe that what they were entitled to get was less than the true entitlements, whilst the share of your income that got stolen by the government got even bigger. It goes without saying, this is still happening today. By the way, they haven't stopped contending that the inflation is overstated. In this decade, support for a fully-substitution-based CPI has been growing. The Bureau of Labor Statistics (BLS), which is the government entity responsible for measuring inflation, has already developed an index of that kind, the Chained-CPI. Now, the only thing left to do is for this idea to gather enough traction among politicians, economic advisors and academia, so as to deceive the public, making them believe that the reports on inflation are overstated, and make the Chained-CPI the primary inflation measure. Hedonic adjustments and substitution in CPI Beginning in the 1980's, actions were taken to reduce CPI reporting through the introduction of hedonic quality adjustments. The BLS expanded quality adjustments to include the concept of “hedonic” quality adjustments, altering the pricing of goods and services for nebulous quality changes that often were not viewed or recognized by consumers as desired improvements. Where the effect here on the pricing of goods and services could not be quantified directly from a pricing standpoint, the pricing impact was estimated by computer statistical modeling (hedonic adjustment modeling) that had little if any relevance to real-world experience. Moreover, where the quality of the product was deemed by the government to have improved (the usual circumstance), prices in the CPI calculations were adjusted lower to offset the higher quality. However, when the quality of the product deteriorates, like air travelling, there's no upside price adjustment. What's more, the consumer only had the option of paying the full price for the product, again with little or no concept of the quality improvement being acquired and/or having no chance to opt out of paying for the improvements. For instance, new computer features usually were deemed quality improvements, with downside price adjustments made in the CPI for the changes, even though a consumer may not have wanted or used the features. Then, starting in the 1990's, it began a push to reduce official inflation reporting, by shifting from a fixed-weight to at least a quasi-substitution-based CPI. Allowing substitution of lower-priced and lower-quality goods in the basket lowers the reported rate of inflation versus the fixed-basket measure. Specifically, BLS introduced geometric weighting - a purely mathematical gimmick that automatically reduces the weightings of goods rising in price, and vice versa - which has no demonstrated relationship to consumer substitution of goods based on price changes. It was explained as a surrogate for a substitution measure. BLS also introduced more frequent re-weightings of the CPI index from every ten years to every two years, which moved the CPI closer to a substitution-based index, but the change was not considered a change in methodology. Moreover, BLS introduced ongoing re-weightings of sales outlets (discount/mass-merchandisers versus Main Street shops), also moving closer to a substitution-based index and detaching from the concept of constant standard of living. Old school methodology The aggregate impact of the reporting changes since 1980 has been to reduce the reported level of annual CPI figures by roughly 7%, where 5.1% come from the BLS’ published estimates of the effects of the individual methodological changes on inflation. The balance comes from ShadowStats estimates of the changes not formally estimated by the BLS. The effects are cumulative going forward in time. The ShadowStats-Alternate Consumer Inflation Measures were created by reverse-engineering the CPI-U-RS series, which was designed to restate inflation history as if all the current substitution and hedonic adjustment methodological changes always had been in place, and adding in estimates of the inflation effects of factors not otherwise estimated by the BLS, such as more-frequent (two-years versus ten-years) re-weighting of the CPI series. The two ShadowStats series are based on the methodologies in place as of the 1980's, and separately as of the 1990's. Illusion of a recovery Since inflation has been erroneously computed, the inflation-adjusted GDP, the real GDP, has been mistakenly calculated as well. Looking at the graphs below, it's pretty clear that the economic recovery in the US from the Great Recession has been a big fat lie. The one on the left is the official reported real GDP, while the one on the right is the corrected real GDP by John Williams. Rest of the world
Throughout the world, government agencies in charge with measuring the inflation have been gradually shifting to a substitution-based CPI. Because economics departments of universities in the western world have all been taken over by the keynesians, the consensus was, and continues to be, that inflation was overstated. Obviously, politicians loved this reasoning and the general public ate this up since it was backed up by the so-called experts. Take the European Union for example. Its inflation measure is called the Harmonised Index of Consumer Prices (HICP), which was developed by the Eurostat (European Statistical Office). In its website, they claim that the HICP is more of a fixed-weight measure than subtitution-based. Thus, they seem to be closer to the concept of constant-standard-of-living, though, the methodology of a cost-of-living index is also in the mix. However, the fact that most countries that implement the HICP (all EU members, Iceland, Norway and Switzerland) update their weights of the basket of goods every year, even though the law only mandates weight updates every 7 years - which is less than the time interval in which the CPI's weights are updated (2 years) -, makes one believe that, in actuality, the HICP is more of a substitution-based index that apply the cost-of-living concept. As they put it: "(...) in cost-of-living indices it is the “consumer utility” obtained from the purchases in the base period that is kept constant. The cost-of-living index therefore measures the change in expenditure necessary to maintain the utility of the base period". Moreover, the HICP has the goal of measuring "pure" changes in price, they believe that a change in the good’s characteristics, either its size, quantity or technical performance, ought to result in price adjustments for these differences in specifications or quality, in order to derive the "pure" price development. The methods to assess the adjustments needed are "based on expert judgments, regression techniques ('hedonic methods') and methods that derive estimates of the pure price change from similar products that are available at unchanged quality in the same outlet ('overlap method')". As you can see, you can't even flee to Europe to escape the US government induced decay of the standard-of-living. Conclusion The government expenses with Social Security and other inflation-adjusted programs and expenditures grew to a point that government would either have to cut them or increase taxes. However, since successful politicians seem to all have some degree of sociopath disorder (because sociopaths are attracted to positions of power, as well as they're the only ones willing to do whatever it takes to be in those positions - but that's a theme for another day), a third diabolical option arose. The government statisticians would understate the actual inflation, taking advantage of the "scientific" justifications provided by the keynesians for changing the methodology and measuring. Almost 40 years have passed and the debauchery still continues, with the general public maintained in the same state of oblivion. To add insult to injury, the keynesians, government statisticians, politicians and economic advisors, up to the present time, keep claiming that inflation is OVERSTATED and, consequently, a campaign to make the Chained-CPI (a fully-substitution-based version of the CPI-U) the primary inflation measure has been gathering momentum. In its turn, the real GDP, which is the GDP adjusted for inflation, has been overstated. In addition, all trends seem to start in the US, moving then to the rest of the world. Hence, this reforms in the calculation of inflation have been occorring all around the world. This is due to the fact that the school of thought followed by most economics departments of universities, especially in the developed countries, is keynesianism. To conclude, across the western world, average citizens have seen its standards of living being obliterated and their representatives not only refuse to acknowledge it, but want to hide this deterioration even further. This explains why even though the government statistics show a full recovery from the Great Recession and, in the case of Europe from the sovereign debt crisis, the people have been very displeased and resentful towards their countries governance.
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March 2024
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