Sunday, May 18, 2008

Understated Inflation?

John Mauldin makes an excellent point regarding inflation perceptions in this week's Thoughts from the Frontline weekly e-letter. In short, consumers pay more attention to the items they buy more frequently and, currently, those are the items that are increasing in price the most.

[H]igh-frequency spending items like gasoline, food, education, and medical care make up 50% of the Consumer Price Index. These are items which we buy on a regular basis. And they are going up at a weighted average rate of 6.8%, a lot higher than the 4% for the CPI as a whole.

The 20% of the CPI which are low-frequency items like furniture, appliances, vehicles, and so on are actually falling at a -0.7% rate. Since OER (equivalent rent) is roughly 30% of CPI and is rising at 2.8%, even as home prices fall the overall rate is about 4%.

Our tendency to notice the price increases in more frequently purchased items more than the drop in less frequent expenditures is known as salience. What we see every day is more visible to us and is on our minds. And because the reality is that those prices are rising much faster than headline inflation, we tend to think inflation is understated.

2 comments:

Anonymous said...

but how can instantaneous, for lack of a better word, purchases be ignored by inflation? if we plan to stick with the current inflation calculation, there needs to be a short term inflation. both inflation calculations need to be taken into account to determine overall market condition.

btw - i found your blog on the R mailing list.

Josh Ulrich said...

The point isn't that inflation of frequently-purchased items should be ignored; but that inflation feels higher when frequently-purchased items are increasing faster than other components.

Glad you found the blog. I hope you enjoy and come by often.

Best,
Josh