Explaining the CPI-U

This Monday's Outside the Box E-Letter by John Mauldin features a great publication from the Congressional Budget Office. To whet your appetitie, here's the introduction:

This week in Outside the Box we look at a Congressional Budget Office publication that dives us the details on how the consumer price index for all urban consumers (CPI-U) is created. This is, as the CBO posits, the best-known official measure of inflation.

The brief that follows will venture to explain the methods used to construct the CPI-U, and how and why the index's estimates of inflation might differ from a consumer's perceptions of price changes. Though I think this article may be somewhat akin to discovering what components comprise the makeup of sausages (knowledge that is usually best left undiscovered), it is useful to understand just how the inflation data is constructed. Some of the points they make are controversial, especially when it comes to "hedonic" pricing, which they refer to as "shifts in the quality of goods and services over time." This does allow for some quite subjective influence in the inflation numbers. While I will visit this topic in a later letter, it is good to know what is and is not being measured.