Inflation and the Price of a Burger

In a pair of recent discussions, the issue of inflation has come up.

In one, someone mentioned that he’d thought that recent inflation was worse than “official” numbers – and the example he gave was how he’d noticed how expensive meat was at the supermarket.

And in another, a question arose regarding how well one might consider home ownership a form of inflation hedge – in particular, should he have to, at some point far in the future, rely on tapping the growing equity in his home for living expenses at the far end of retirement, would it provide protection against the impact of inflation?  This is especially important for someone with a fixed pension (unlike Social Security, not all pensions have annual inflation adjustments — and even some which do have them have adjustments which aren’t actually tied to any real measure of inflation).

Here are some things we all need to understand about inflation, and in particular, on how the government defines it (or, at least, measures it at the BLS):

From the dictionary (on my computer):

inflation |inˈflāSHən|nounEconomics a general increase in prices and fall in the purchasing value of money: policies aimed at controlling inflation | [ as modifier ] high inflation rates.

The “official” measure of inflation generally accepted is the Consumer Price Index, in particular, the commonly used one is the “CPI-U” which is the Consumer Price Index as experienced by by urban consumers for a representative basket of goods and services.

Sometimes the numbers quoted take that basket and exclude energy and food prices, not because energy and food don’t increase or change in price, but because they tend to be much more volatile than the rest of the index and make the series of data much messier in the short term without really affecting it much (because food and energy increase in prices similar to most other things) over longer terms.

The way in which actual everyday spending is affected by (or affects) the CPI depends on how the various items in that “representative basket” are weighted.  The things on which people spend the most have a bigger impact than small, inexpensive or infrequently purchased items.

So, not surprisingly, a huge portion of the CPI is comes from housing, in particular, “imputed rent” on owner-occupied housing – which, for all the sophistication of their analysis, is ultimately just an estimated number based on a survey of homeowners asking them how much they think their homes would rent for. And “imputed rent” is just part of the housing portion in general.

Our recent experience of this is telling: while home prices and rents are starting to go up in the more constrained areas, in the aggregate, it’s been pretty modest. Imputed rent is around 24% of the CPI and actual rent is another 6+%. A lot of other big-ticket items have been very moderate, too (i.e., vehicle prices).

Even within food recently, most of it has been very moderate (i.e., 2% or less). Specifically, meat, poultry, fish, eggs and dairy have been higher — but they add up to less than half of total at-home food. Those things all fall into two categories which are 1.9 and 0.9% of the total CPI — while they are very noticeable, they are, in actuality, very small fractions of people’s spending. And, as visible as they are, meat and dairy have gone up a lot: 7.7% for the meat group – the single highest increased category in the CPI.  But a relatively big increase in a relatively tiny part of one’s budget does not make for high overall inflation.

Nevertheless, in terms of visible spending – especially for retired folks with paid-off homes on fixed incomes — categories like food and “everyday spending” may loom much larger. If you’re not actually paying any rent (or mortgage), all the non-rent items have a substantially higher impact. Those same folks are also being, generally, hit harder with increases in the costs of medical services – another area that has outpaced overall inflation handily. Every individual has his own personal actual rate of inflation and nobody’s is exactly like the CPI.

As for a paid off home as an inflation hedge, it works almost by definition.  With well over 30% of the CPI based on changes in home prices, and ignoring the fact that home prices are highly individual and location-specific, if homes in general are going up in price/value, so, too, will the official definition of inflation per the CPI.  Compound that with several additional facts regarding one’s primary home — (i) it’s typically purchased with a lot of leverage against a fixed interest rate loan – so while the home goes up in value, and while the loan gets paid of steadily, the actual rate of growth of equity in the home generally is faster than the home price itself for a long time; (ii) there are several tax advantages – between deducting mortgage interest and property taxes, as well as (in California) Prop 13 keeping a lid on property tax increases, as well as preferential federal tax treatment of long-term gains in one’s primary home — all of this can make a steadily paid-off primary home a great long-term inflation hedge and general store of value.

Finally, related to all of this, the Wall Street Journal posted, on July 6, 2014, the following article, worth reading:


As Food Prices Rise, Fed Keeps a Watchful Eye

Central Bank Officials Sometimes Look Past Food-Cost Increases

U.S. food prices are on the rise, raising a sensitive question: When the cost of a hamburger patty soars, does it count as inflation?

It does to everyone who eats and especially poorer Americans, whose food costs absorb a larger portion of their income. But central bankers take a more nuanced view. They sometimes look past food-price increases that appear temporary or isolated while trying to control broad and long-term inflation trends, not blips that might soon reverse.

It’s by urban consumers for a representative basket of goods and services.

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