Why you should fear inflation: The CPI understates the true nature of inflation. BLS only allocates less than 2 percent to tuition in CPI. Missing big on the biggest expense in housing

April 8, 2014 in News by The Manimal

Source: My Budget 360

Some people believe that inflation is simply a part of the normal economy like seeing the sunrise every day.  Over time prices will rise on everything, or so the argument goes.  I’m not sure if most dig into the question any deeper and question the nature of prices rising.  If we look at inflation over generations the dramatic impact is clearly seen.  If we see a reasonable rise in wages that accompanies higher prices then things typically even out and the public goes on with daily life.  However, what we have seen for more than a decade is that wages are simply not keeping up with the overall change in prices.  The middle class is disappearing because purchasing power is getting weaker.  Sure, starting in the last two decades people went on a debt binge and this masked some of the loss in purchasing power but debt needs to be paid back.  The loss of good paying jobs is a trend that continues and higher prices in housing, medical care, and college tuition continues to eat into the money Americans currently have.  You feel poorer because your dollar is getting eaten away by inflation.  The BLS tries to measure inflation by looking at a basket of goods in their CPI but misses on weighting some major components accurately.  For example, it radically understates college tuition and housing costs.  Inflation matters more than some people think.

College tuition dramatically understated in CPI

The Consumer Price Index looks at many items purchased by Americans and tries to develop an index that tracks changes in prices.  The CPI does a relatively good job in some areas but does a poor job in areas where price changes are occurring dramatically.  For example, a larger portion of our population is now going to college.  College tuition has outpaced wage increases dramatically since 2000.

Let us look at how things have changed since 2000:


Energy prices are up 115 percent since 2000.  College tuition and fees are up 130 percent.  The problem is that the CPI only gives a 1.734 percent weighting for tuition.  Well what if you are a student going to college during this era where tuition is soaring?  It doesn’t matter in the context of the CPI because less than 2 percent of the basket looks at tuition.  Since college is now becoming a near prerequisite for access to a middle class career, this is becoming more of a necessity versus a luxury.

College tuition isn’t getting cheaper:

tuition increase

Across the board, going to college has gotten dramatically more expensive and for many young Americans, the cost of going to school is a giant expense (certainly more than the 1.734 percent weighting given to this one item).  This is also a reason why the wealth gap between young and old Americans is also so dramatic in real terms while the overall inflation rate looks tame.  Inflation looks tame if we look at the overall CPI but again, take into account what is going on with generational differences here.

Funny math with housing – owners’ equivalent of rent

The CPI does a poor job of measuring home prices.  Most Americans own a home.  So it is interesting that the CPI uses an owners’ equivalent of rent (OER) measure instead of looking at the actual cost of buying a home.  If you look at the CPI, housing costs have only gone up by 40 percent since 2000.  This is directly in line with the CPI coming in at 39.5 percent.  Yet a better measure is the actual price of a home:

case shiller

The Case Shiller Index which does look at the actual sales price of homes shows that home prices are up 68 percent from 2000.  That is a big difference from what is being reported in the CPI.  The Case Shiller also clearly saw the housing bubble in full context while the CPI completely missed the housing bubble thanks to the OER measure.  Why did it miss this?  Because rents were not rising as quickly and funny financing of homes kept prices artificially low until the entire thing imploded.

What has been done to fix this?  Nothing.  And keep in mind the Federal Reserve kept pointing at low inflation as a reason to keep rates artificially low and inflated the bubble to a point where it brought on the Great Recession.

Housing is the biggest expense for most Americans so it is surprising how poorly the CPI does in reflecting the true cost of home ownership.

Falling income

As we mentioned before inflation with comparable wage increases is usually ignored by Americans.  However, when wages do not keep up with the overall cost of goods that is when you see a loss in purchasing power.  Take a look at wage growth since 2000:


Wages are up 30.3 percent since 2000.  However the CPI is up 39.5 percent.  This is why adjusting for inflation, wages are down 6.2 percent since 2000.  Yet the pain is deeper than this because of how little weight is being given to tuition in the CPI basket.  For young Americans, this is likely their biggest expense for many years and the expense is dramatic (and many cannot afford it without going into massive debt).  Student debt outstanding is now at $1.2 trillion.  Jobs that are being added are in the low-wage segment of the economy.

Inflation absolutely matters and the above gives you a good idea as to why many Americans now feel that achieving a middle class lifestyle is much tougher.  Eroding purchasing power one day at a time takes a toll over the years.