Consumers' Sense of Inflation

Some weeks ago, at lunch with some friends, one of them was complaining about the absence this year of a cost-of-living increase in Social Security benefits.  Indeed, that feels irritating, and, more, for people who have their Medicare Part D premiums deducted from their checks, their net benefit will actually go down a little.

The complainer at our lunch table further asserted that the government “manages” the consumer price index so it can avoid the benefit increase.  Fortunately, the meal-time conversation then shifted to more pleasant topics, but her comments registered with me as something to talk about here.  This is especially the case because it seems people also have a sense that there’s more inflation in general than the official numbers seem to show, making them believe that the purchasing power of whatever their income, whether retirement benefits or actual earnings from jobs, is being squeezed.  Maybe it is . . . .

In the 12-months through November, the consumer price index (CPI) was up a mere 0.5%.  And in the period ended in September, which determines the following January’s Social Security “cost of living” increase, the CPI was flat: it did not increase.  And as our accompanying graph shows, that had been true in most months of 2015.  Thus, according to this measure, there was no inflation.

The CPI Comes from Thousands of Items and Thousands of Stores and Service Providers

It's important to know that the government does not, in fact, “manage” these consumer price index data.  They are collected in great detail, according to huge surveys that ask about what people buy and where they buy it.  Then,  every month, employees of the Bureau of Labor Statistics (BLS) visit thousands of stores, service businesses, apartment management offices, doctors offices and hospitals, among other outlets, to collect price information on carefully specified items; these items currently number some 80,000 every month.

The businesses they visit are selected from among those specified in an occasional “Point of Purchase” survey also conducted by the BLS from about 14,500 families.  The items themselves come from the “Consumer Expenditure Survey”, which collects information on what people buy; if you happen to be a participant in these surveys or you know someone who is, thank them for their help.  Some of them, 7,000 of them, have kept a diary of every single purchase they have made over a two-week period, and another 7,000 have answered detailed questions in a quarterly interview.  Altogether, in a recent two-year period, 28,000 diaries were consulted, along with 60,000 interviews.

Finally, when the current prices are collected, they are examined by BLS specialists who check to make sure the specifications for an item have been followed as closely as possible so quality changes are not factored in – for instance, the “car” is the same make and model with the same features as the one last month.  All these BLS survey-takers and fact-checkers are civil servants, not political appointees.

If the CPI Is Flat, Why Might People Think There’s Inflation?

If you think, contrary to these carefully compiled government data, that there is in fact “inflation”, you are hardly alone.  A couple of private surveys agree: the Conference Board’s monthly Consumer Confidence Survey shows that its 5,000 participants estimate that the CPI is running up at about a 5% rate and has been for some time.  A smaller poll of 1,200 nationwide taken for the New York Federal Reserve Bank indicates that people think the CPI will go up 2.6% in the next year.  Both of these exceed the growth in weekly earnings also compiled by the BLS.  From December 2014 to December 2015, these wages for non-management workers were up 2.1%, less than either private survey inflation estimate.  So workers’ pay as well as Social Security benefits can seem inadequate to keep up.

We tried to figure out how this discrepancy might have developed; how might people feel there is more inflation than there really is?  We identified two factors.

One is that people’s inflationary expectations vary by age and income.  In the New York Fed’s survey, participants over age 60 see a 3% advance in the CPI over the next year, while those between 40 and 60 look for 2.4% and those under 40, 2%.  Big difference.  Income matters, too:  people with incomes over $50,000 expect about 2.4%, while those whose incomes are under $50,000 believe inflation will be 2.9%.  So if someone is better able to absorb price increases, they are less worried about higher inflation.  While there are just 2-1/2 years’ worth of responses in this survey, this relationship has pretty much held throughout.

The other factor that stood out concerns energy prices.  We all know that gasoline has been much cheaper throughout the last year than it was through 2014.  That and other energy items, such as electricity, turn out to be the main force slowing the overall CPI.  Excluding energy, the CPI was up 1.9% in November from a year ago, compared with the mere 0.5% rise in the total index.  So clearly, there were a bunch of items whose prices rose noticeably.

The most visible of these include rents and homeownership costs, up 3.6% and 3.1% in November from November 2014.  The demon health insurance rose 3.6%, medicines were up 2.7% and dentists – which  many people pay out-of-pocket – 2.8%.  Local public transit fares were up 2.5%, boys’ clothes 3.6%, infants and toddlers’ clothes 4.9%, certain fresh vegetables 4.1% and restaurant meals 2.5%.

Clearly many other items either fell or rose much more moderately, for instance, prices of women’s clothes fell 2.7% and shoes and boots fell 0.5%.  But the increases in such basic items as rent, transit fares and medicines can give the subjective impression of more general upward price pressures.  And people can easily extrapolate this impression into a forecast that more widespread inflation will return, rendering their limited earnings even less adequate.

An Inflation Outlook for the Year Ahead

We checked out some economists’ forecasts of inflation for 2016.  Their projections are not as high as the consumer surveys, but they do look for some inflation.  The National Association for Business Economics survey published in early December shows the CPI up 2.0%.  Another composite, the Survey of Professional Forecasters, compiled by the Philadelphia Federal Reserve Bank, also has 2.0%, while the Federal Reserve Board’s compilation of its officials’ forecasts shows a slightly different inflation measure at 1.6%.  These numbers are close to the recent pace that excludes the drop in energy prices.   What this suggests is that if people’s earnings are up 2.0% next year, they can “keep up” with inflation, and maybe after a few more months, they will feel better about the adequacy of their paychecks.  But Social Security beneficiaries – and government workers whose pay is also tied to the CPI – are still stuck until early 2017.  Just know that the price index data are carefully and objectively collected and combined.  The government did not push the numbers down deliberately to try to save itself money.

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Sources:

For information on the CPI data collection methods, see http://www.bls.gov/cpi/cpi_methods.htm . 

The Conference Board is a nonprofit organization that studies and advises businesses in leadership issues, the economic and regulatory environment and human capital topics.  It conducts conferences and publishes articles on these topics.  Its consumer confidence survey dates from 1967.  https://www.conference-board.org/data/consumerconfidence.cfm

The Survey of Consumer Expectations from the New York Federal Reserve Bank is new, just from June 2013.  It is conducted by The Demand Institute, an organization operated by The Conference Board and Nielsen.  One of the New York Fed’s motivations, besides compiling the basic information, is to provide additional background information for monetary policy decision-making. https://www.newyorkfed.org/microeconomics/sceIndex/index.html

The National Association for Business Economics forecast survey is here: http://www.nabe.com/NABE/Surveys/Outlook_Surveys/December_2015_Outlook_Survey_Summary.aspx.  This is a composite of forecasts from 49 of this trade association’s members.

The Survey of Professional Forecasters is https://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters ; this is a similar group of economists to the NABE survey.