Two Views of "True" Inflation

Yesterday's testimony and Q&A session with Fed Chairman Ben Bernanke before the Senate Budget Committee had a couple of interesting moments to go along with much of the same sort of prattle that was the norm during Alan Greenspan's tenure.

The Chairman of the Federal Reserve telling Congress to rein in the budget deficit and fix entitlements seems like it's been playing on a continuous loop for the last ten years.

One thing that was different this time was that Chairman Kent Conrad (D-North Dakota) made a point early on about distinguishing between the budget deficit and the increase in debt. It seems that the great strides made recently in cutting the budget deficit in half, down to $248 billion, were all a bit of a ruse since the total increase in debt over the same period was $546 billion.
Congressional hearings have a whole different feel now that the Democrats hold the gavels. For the last ten years the first 20 minutes of a session such as this would have been consumed by eight or ten elected officials heaping praise on Alan Greenspan for the fine work he was doing.

Now, all they seem to want from Ben Bernanke is help in solving the massive long-term financial problems facing the government and its citizens.

Alan Greenspan had it pretty good.

"True" Inflation

By far the best part of the Q&A session had to do with measuring inflation.

In an insight to how the current Fed Chairman views the world of money and prices, he spoke about what he called "true" inflation, or, as Merriam-Webster might put it, the measure of inflation that is "in accordance with the actual state of affairs" or "conformable to an essential reality".

Sen. Wayne Allard (R-Colorado): The Bureau of Labor Statistics has recently introduced a new price index, it's called the "chained CPI". I wonder if you'd elaborate on that - they're claiming that it's more accurate than the current CPI. I would like to hear your feelings on that new measurement.

Ben Bernanke: Yes I think it is somewhat more accurate. The existing CPI, the one we're all familar with, takes a fixed basket of goods and values the change in the cost of that basket from month to month and from year to year. The problem with that is that it doesn't take into account that as prices change, people will change the goods and services that they choose - if oranges become more expensive, I might eat more apples.

The chain weighted CPI allows, to some extent, for adjustments that people make to go from higher price goods to lower price goods, and therefore is probably a better measure of the true cost of living increase than the standard CPI.

Allard: Do you think that the procedure that we're using now at the CBO and the OMB, that those projections overstate inflation?

Bernanke: Well, presumably the projections they're making are in terms of what they think the standard CPI inflation will be. At the Federal Reserve we've done numerous studies of these indices and we do think that the standard CPI does overstate "true" inflation, if we could measure "true" inflation, by some amount between a half and one percentage point.

Allard: Do you think we could go to those agencies and change CPI to get a better result?

Bernanke: Well, the operational question that we might ask is whether we should use the chained CPI or some other measure to index entitlement benefits or index the tax code. In congress, if your objective is to tie benefits payments and the tax code to what I would call "true" inflation, you would have a more accurate measure of "true" inflation by using the chained CPI or some alternative measure.

So, given last year's overall inflation of 2.6 percent, "true" inflation - the measure of price increases that are "in accordance with the actual state of affairs" or "conformable to an essential reality" - would be just below two percent.

An Alternative Essential Reality

The definition of "true" inflation for Ben Bernanke stands in stark contrast and will comes as a great surprise to Jim in Washington who wrote in response to Tuesday's post, Seniors in Debt. Jim has granted permission to share some of his thoughts:

I am a disabled veteran, I am no where near being elderly at 49, yet I am on a fixed income just as the retirees are. My veteran disability check is $2,314 per month, and that is not (income) taxable, I also get full medical and dental with no cost to me.

When this payment began in February 2005 I was able to get by relatively comfortably, I would not say it was middle class because I could not afford to buy a home (my first prerequisite for entrance to the middle class is enough money to AFFORD a home which eats no more than 33% of gross income for PITI), I was in California and that was simply not even close to enough income to buy even the cheapest house on the market. So, not middle class but close for one doomed to rent the for next 30 years.

Twenty four months later I can tell you that prices have so far outstripped these puny COLA raises the congress has granted that I am now actually considering going homeless, at least for the four months of the year when weather is warmer.

The new improved "chained CPI" may capture this substitution effect.

This year was a classical example, the congress initially announced a 4.1% COLA for retirees and veteran's , but the GOP on the hill said that was too much and they got their way in one of their last acts before getting curbed by the democrats in the elections. They trimmed the COLA to just 3.3%, that was in a year when my landlord raised rents from $700 to $800, some 15% for the renewal on the lease. Rents are up even more since. Food is getting to be a problem, and I have had to resort to the food bank more than once.
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My living standard has not just noticeably dropped it has plummeted. I am scrambling to pay off my only credit card with a balance of some $2,500 because I cannot afford the interest and fees. Mind you I am one of the LUCKY ones, my income is far higher than most on social security or other disabled veterans even. It seems every month I have to find something else to cut out, and every month I find prices spiking all around me, a haircut went up from $12 to $15, a car wash at the automatic place went from $5 to $6.
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This is the reality for fixed income people, the federal government is blaming retirees and disabled people for their budget problems, Bernanke said it today, if they do not CUT entitlements the USA will be bankrupt.

This is a gross violation of the social contract by which the USA was able to build a thriving middle class in the first place, and I am not alone when I say that the middle class is the goose that laid the golden eggs that the rich so enjoy. Their greed is so boundless that they do not care if old folks die or veterans live out of dumpsters.

They WILL care however when these millions come and haul them into the town square for a lynching. So, they will hire some of the poor to be in their private armies and we will have taken the last steps to feudalism again.

Economists really do need to occasionally pull their noses away from reports and computer screens full of statistics and get out more.

Apparently, "truth" is all a matter of perspective.