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Ideas & Trends; How Accurately Does The Government Measure The Pinch of Inflation?

how does the government measure inflation
Published: April 7, 1991

WASHINGTON— TO many consumers, suffering such real-life financial jolts as $140 traffic tickets, $50 drugstore prescriptions and $1,000-plus annual increases in college tuitions, the nation's official retail inflation gauge seems somewhat disconnected from reality.

Their perception, particularly at a time of slowly growing incomes, is that prices bound ahead even when the Government reports, as it did at its latest reading last month, that inflation during the latest three months ran at the relatively modest annual pace of 3.9 percent.

Anecdotal evidence, economists have learned, can be dangerous, but it does underline some of the limitations inherent in the closely watched Consumer Price Index, which monitors the rate of inflation. Most economists view the index as one of the more reliable of the Government's statistics.

And at the moment, most economists say, the index seems to be giving an accurate reflection of inflation. Still, an understanding of some of its limitations can provide a better understanding of both individual circumstances and the shape of the economy overall.

Of the various criticisms leveled against the index, one of the most often cited is that it fails to adjust sufficiently for improvements in the quality of a product, such as faster computers, or more sophisticated medical care, or changes in the configuration of a product, such as automobile producers making more options standard. Some critics have suggested that taxes ought to be considered as a factor.

"We don't know how to measure all of these things," said Jerry L. Jordan, chief economist for First Interstate Bancorp in Los Angeles. He cites banking services and computer software as areas where output -- and thus unit cost -- is particularly difficult to gauge.

Another source of confusion is that the price index is designed to measure inflation, not the cost of living. Its so-called basket of goods and services rarely changes even though in hard times consumers tend to substitute cheaper products for more expensive ones -- they eat hamburger instead of steak.

And even if the index were perfect, psychology suggests that perceptions of inflation would be skewed by everyday experience. The typical consumer observes the price of a gallon of gasoline daily but may well go for years without knowing, say, the going rate for a new roof. Perception and Reality

"People's perception of inflation tends to be higher than the actual inflation rate," said Jason Bram, associate economist at the Conference Board, a business research group.

In addition, producers and distributors find it relatively easy to impose big percentage increases on frequently purchased, low-priced goods such as candy or postage stamps. Consumers will notice but probably not object.

One of the biggest criticisms of the consumer index comes from Albert Sindlinger, the veteran researcher whose data come from polling. Taxes should be not be left out, he said. By his calculations, an appropriately constructed index would show that, primarily because of taxes, consumer prices over the last year climbed more than twice as fast as the 5.3 percent posted by the Government's rate.

"Inflation is far from under control," Mr. Sindlinger insisted. His own inflation index was "in tandem" with the Government's throughout 1988 and 1989, he said, but it has jumped 13.5 percent over the last year.

To one degree or another, many economists agree with Mr. Sindlinger: Consumers have less money available now for discretionary purchases than is generally assumed, and they will

be financially unable to fuel an economic rebound even though confidence has revived.

"Conceptually, he's right," said Irwin L. Kellner, chief economist for the Manufacturers Hanover Company, who once created his own index of so-called nuisance items such as toothpaste and candy. "I wouldn't want to be pinned down to his specific number."

For all its deficiencies, the consumer index is defended by an array of private economists as well as its sponsors within the Labor Department.

Martin Fleming, chairman of the statistics committee of the National Association of Business Economists, and an economist for the Cahners Publishing Company, a Massachusetts-based company with a string of trade magazines, called it "one of the better" Government statistical series and said the omission of income taxes -- the consumer index does include excise and other taxes -- is quite proper.

"It really stretches the notion of what a consumer price index is" to calculate inflation as Mr. Sindlinger does, Mr. Fleming said, suggesting that in any event the burden of recent tax increases has fallen mainly on the well-to-do, who, among other things, lost a long-time favorable treatment on the sale of capital assets in the 1986 tax overhaul.

During the early part of last year the consumer index almost certainly overstated inflation because of the foot-dragging way it measures housing, Mr. Fleming asserted. The Government includes six-month-old housing prices, which have the effect of overstating inflation when prices are in a downtrend. The cost of medical care, he added, is almost always too high because there is no prompt adjustment for quality improvements.

Britain Includes V.A.T.

Over the last 20 years or so, considerable work has been done on how income and Social Security taxes might be incorporated into the consumer index so it would be more accurate for wage escalation and certain other purposes. Britain adopted such a gauge in the 1970's when it imposed a value added tax.

However, Government and academic researchers in this country have calculated that a tax and price index would have shown only moderately higher inflation than the consumer index, at least through the mid-1980's. According to Robert Gillingham, a former Labor Department official who is now a deputy assistant Treasury secretary, tax and price index inflation averaged 6.9 percent between 1967 and 1985, just seven-tenths of a point more than the 6.2 actually posted by the consumer index.

He said he was "skeptical" of Mr. Sindlinger's current results, asserting that there has been no appreciable increase in income taxes during the last year or so to cause the Sindlinger index to accelerate sharply. "There's some quirk going on if it's 13 instead of 6," Mr. Gillingham said, referring to the inflation rate.

Mr. Sindlinger said his information consisted of responses to a survey question he has asked consistently since 1972: Are all forms of taxes costing more, less or the same compared with a year earlier?

"It's a psychological question," Mr. Sindlinger said, acknowledging that many taxes, including property taxes, are directly or indirectly included in the consumer index. "It all comes from interviewing."

In the end, debate over whether the consumer index is significantly underestimating inflation can seem rather abstract to the householders on whose views Mr. Sindlinger has built a handsome business and who regard themselves, correctly or not, as financially pinched.

"Higher tax rates are cutting into disposable personal income," Mr. Sindlinger said. "Consumers are complaining to us -- and can't take much more."

Category: Bank

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