Inflation Statistics Don't Always Tell the Truth

Academic economists have long grumbled about the unreliability of official inflation data, but the belief that things are worse than governments are willing to admit is trickling down from the ivory tower. Even Charles Bean, the new deputy governor of the Bank of England, has publicly criticized central bankers' use of "core inflation" data, which disregards food and energy prices, in setting policy. When "non-core" items like gas and cereal rise so much that consumers have little cash to spend on anything but those essentials, it's hard to ignore.

The temptation to fudge numbers is one that bureaucrats worldwide find hard to resist. In Argentina, where government reassurances about single-digit inflation have long seemed unconnected to consumer reality, revamping the government statistics office became an issue in the last national election. In China, where data based on the prices for state-provided goods and services are increasingly irrelevant in a privatizing economy, the stats are so out of whack that Goldman Sachs has resorted to a movie-review-style system to rank the quality of official data on a scale from one to five. But the habit of playing fast and loose with numbers isn't native to the developing countries where high inflation reigns. Indeed, the popular "core inflation" method for measuring changes in consumer prices is actually as all-American as Enron's accounting practices.

In the early 1970s, the United States found itself vexed by a newly powerful cartel of foreign oil producers, a 300 percent rise in crude prices and a new and unpleasant realization that Americans were no longer the sole masters of their own economic house. Rather than reining in its own politically driven monetary policies to slow the surge in consumer prices accompanying the oil shock, the Nixon-era Federal Reserve hit on the novel strategy of trying to cover it up instead. The traditional "headline" inflation rate, measuring the rise or fall of an average of all prices for a broad basket of goods and services, was nudged aside in favor of an index that stripped out the supposedly more volatile categories of food (subject to price spikes due to weather or plague) and energy (subject to price spikes due to unfriendly foreigners). Consumers may still have felt pain at the gas station and grocery store, but the government would no longer officially confirm their discomfort.

Manipulated numbers notwithstanding, high inflation would outlast the Nixon years, and by the end of the 1970s, futzing with the figures that measure it had become common. Prices of everything from used cars to children's clothing were given the heave in order to make the numbers look better. As control of the White House shifted from Republicans to Democrats and back, both parties needed to avoid giving the impression that inflation was actually worse than it had been when the other guys were in power.

By the mid-1990s, while stodgier central bankers in Europe and Britain still clung to old-fashioned headline inflation to guide policy, the United States was rolling out "hedonic adjustments" that used technological breakthroughs to justify adjusting inflation estimates downward, even when advances like faster computer processors didn't touch most people's lives, let alone boost their spending power. And just in case technology didn't bring prices down fast enough, the United States enthusiastically embraced "substitution effects," opting to measure hamburger prices instead of steak if steak prices rose unpalatably. Even a boom in house prices could be negated simply by choosing to count slow-rising apartment rents instead of soaring home values.

So what to do if governments can't be trusted to get the data right? Try doing it yourself. To this end, the United Kingdom's national statistics office offers a personal inflation calculator on its Web site that lets consumers create their own index based on personal observations. As Groucho Marx might have said, "Who are you going to believe—the Fed or your own eyes?"