Inflation Fraud: How Calculation of the US Inflation Rate is Rigged

Working in collusion, the Federal Reserve and the United States’ government maintain a US inflation rate that understates what people actually experience. The media glee club faithfully parrots the numbers given to it by the federal government, but no one in the major media questions how those numbers are determined.

I’m inclined to say the numbers are rigged through collusion of the federal government and Federal Reserve because their choice in how to estimate the US inflation rate skews the facts, as I’ll demonstrate. I think calculations are considerably different from what Americans actually experience. Anecdotally, many people say they feel inflation’s pinch, even as the government and Fed report year after year that inflation has been almost nil. Here is why:

What leading factor in government calculations skews the US inflation rate?

Is not the vast majority of your money spent on either the house you are buying or on rent? For most people it is, which is why the government weights the cost of shelter highest among all the items included in its inflationary basket of goods and services used to calculate how much your cost of living is changing.

You might wonder, given this high weight, how inflation only rose 1.3% year-on-year in September when rents rose 3% year on year and housing prices rose 5%. One would think that could only happen if a few other large expense items on the typical American’s list of monthly expenditures fell a great deal while housing rose. Clearly energy is another one of your major-ticket items — to run your car, keep your lights on, heat your house — and clearly energy has fallen in 2015, so maybe that explains it. Right?

It could, but let’s take a deeper look at housing for a minute: The government showed an annual increase in rent of 3%, but other rental statistics show they went up over 5%. Which number feels right to you? With housing being the government’s highest weighted component in it calculation of CPI, a 2% skew makes almost a 1% change in the rate of inflation. The 2% difference can’t be due to seasonal adjustment of the government numbers because the government’s number is a year-on-year figure, not a change from one month to the next. So, why was rent dropped two points in the CPI calculation from what real rents have done? (The same kind of difference appears in the government’s calculation of the cost of home ownership.)

In 1982, the Bureau of Labor Statistics felt that shelter was being given too much importance in the calculation of inflation because housing prices were rising so fast. So, the bureau created a fiction called Owner’s Equivalent Rent. Rather than using the actual change in housing prices, the government asked homeowners, “How much would you expect to pay in rent in order to live in the same house you are currently buying.” The average of all the answers to that sampling poll became the government’s number for the housing component of what the average homeowner pays out in expenditures each month for shelter.

Right off that means the government’s calculation of homeownership cost is based on nothing more than the average home owner’s guess about rental rates on an equivalent home. One justification used for this poll-derived calculation of the best guesses of average citizens is that, by looking at rental equivalents rather than real housing price changes, the government can adjust for changes in interest rates and property tax rates that landlords include in rent that can change outside of the change in housing prices.

I think that ridiculous. True, property tax rates and interest rates might have dropped in the same year that housing prices rose, making the real cost of home ownership somewhat less than the rise in housing prices would appear. Wouldn’t it make far more sense, however, to simply make sure your poll includes the real changes in those rates as well. That’s easier information for the homeowner to provide than a good guess and equivalent rental value!

Here’s how the government’s oddball method skews the US inflation rate: Rent changes clearly lag behind the changes in housing prices, and the average homeowners knowledge of what rents are probably lags behind the rent changes. Because homeowners are not renters, they are usually not paying close attention to rental rates. It’s absurd to take the highest-weighted item in the CPI calculation and base it on what non-renters would guess about rental rates. The lag time between the change in rent and the change in home prices, plus the guesswork skews the government’s estimated cost of shelter downward because the rent costs people are aware of (if they are aware at all) are going to be behind the market’s curve. The sampling method also creates the opportunity to manipulate the sampling by who you include and who you don’t.

If there is no mathemagic involved, how is it that housing costs by the rental-equivalent method are so much lower than the real change in housing prices, which went up so much this year? Interest rates certainly haven’t changed much. Did property tax rates across the nation plunge? Not likely when all governments seem starved for revenue.

Wouldn’t it make more sense to think that housing prices went up month-after-month in fairly large amounts, while rental rates have been slower to follow? Rental rates are, after all, a reflection of housing prices, and there is always reflex time. The change in housing prices only immediately affects rental rates of homes just purchased. Other rental homes are often on one-year leases, so the price is locked in and cannot go up each month. Only the homes with expiring leases can go up as housing values rise, and owners are sometimes reluctant to raise rates, lest they lose a good renter. Unless a house was just purchased, the rent doesn’t NEED to go up due to a change in housing prices because the landlord’s cost of owning the home didn’t go up. As a result, rent tends to creep up as new homes are added to the rental pool that have to charge more, giving room for leases to rise when renewed. There is, in other words, a strong connection between the monthly change in home prices and rent, but there is also a lot of lag time.

Since the government created the Consumer Price Index (CPI) as a way to calculate the US inflation rate and determine how much of an annual increase it should give in government salaries, social-security benefits, etc., the government benefits hugely from this float. The lag time keeps the annual cost of the largest single factor in the consumer price index as low as possible. If it just shaves two points off of CPI every year, that compounds year over year because the government saves the two points on the percentage change that they apply, but they also are applying the percentage change to a number that was 2% lower than it should have been due to a similar adjustments the year before. Over time, this compounds to a huge savings.

To be fair, the government cannot factor homeownership costs based just on the known change in housing prices because most homes don’t resell each year. Only a portion of homes sell each year and move up in price, which means many consumers may face no rising cost in a given year. So, how do you average that out?

Would not a more accurate way of calculating the change in the cost of shelter for homeowners be to sample homeowners and ask them, not to GUESS how much it would cost to rent an equivalent home, but how much they are actually paying in combined principal, interest and property tax in a sampling that balances the proportion of new owners and longer-term owners to match reality? (Other costs of ownership are included in the prices of goods and services people buy … or should be. For renters, those are included in the cost of rent.)

The amount that people are actually paying out each month in property tax and mortgage payments (which are usually combined anyway) is surely superior information compared to the average citizen’s best guess about a rental market he or she isn’t even participating in! A number that changes what every retiree in the United States receives in Social Security payments and that is used as a benchmark for adjusting wages relies on my best guess of as a homeowner of what it would cost to rent what I’m buying? Are you kidding me? (Speaking for myself, I have no idea what it would cost me to rent the forty acre farm we’re buying because I have no reason to care!)

That seems like such a bizarre way to figure out what the real change in the cost of homeownership is that I say the government’s method is rigged and fraudulent. So many smart people cannot possibly have failed to think that my simple solution toward getting real numbers would be more accurate than the guesswork of thousands of homeowners. People could look up their actual house payments much faster than they could try to guess equivalent rents and give numbers with total precision. The shear lunacy of the government’s method inclines me to think the government doesn’t want real answers.

Hey, I’d like to know the monthly cost of buying a 2014 Toyota Prius in your market. Why don’t I call thousands of bicycle owners to find out how much they think it costs to rent a 2014 Prius and use that number? They oughta know! (Banging head on wall.)

Though your housing payments may only go up a little due to property tax increases or adjustable interest each year, they will take a huge leap when you move to a different home. CPI needs to average out those quantum leaps that affect you only upon new purchases or refinancing. However, as long as the sample in my method balances new owners with longer-term owners and refis in the right proportion, the average change each year should be a good estimate of how the change in housing prices impacts homeowners.

Other factors that skew the housing calculation in the US inflation rate

It is not just the homeowner’s side of the equation that is skewed. CPI’s calculation of rent payments is also slightly skewed. The Bureau of Labor Statistics asks people how much rent they pay, less the amount paid by government agencies (welfare). Well, hold on; the portion of rent subsidized by government agencies may not be that consumer’s cost, but it is a cost ultimately born by all consumers through their income tax. Since income tax changes are excluded from CPI, you cannot just take that part of rent out of the equation as though it has no impact on the cost of living. It may not be an immediate cost in a world of deficit spending, but it is a cost increase this year that becomes a future liability for taxpayers. So, I’m not sure that ignoring it is the right approach.

Moreover, both the rental and homeownership calculations include an additional lag. Because they are more complicated to calculate than the change in other items, the government only reruns the numbers with a new sample every six months, instead of every month as is done for most other items included in the US government’s CPI calculation. That means that the monthly figures are off from reality, except twice a year, though it would not affect the annual CPI figure.

Biases that are claimed to overstate calculation of the US inflation rate

Some say the US inflation rate is overstated for the following reasons:

• Consumers can and regularly do substitute items when the price of one item goes up in order to keep their cost of living from rising; but the items measured in the government’s mythical basket of goods and services that are monitored do not change as quickly as consumers make substitutes. (I’d argue that substitution is still a rising cost that needs to be quantified. People are paying in terms of either lowering the quality of items they switch to or enduring items they desire less (such as switching from oranges when their price rises to cheaper grapefruit). They are lowering their standard of living on those items due to the fact that the price has gone up while their wage has remained stagnant. That’s a real cost.
• Quality changes are not adequately accounted for in the government methodology. As stated above, the government switched its method of calculating inflation back in 1982. The newer method tries to target the cost of a fixed standard of living because, if standard of living is going up while the cost remains flat, that implies price deflation. The price of computers, for example, may not have changed at all, but the quality of computers has skyrocketed. So, your standard of living in terms of your top-of-the-line personal computer has improved astronomically without a price increase. Therefore, you could buy a low-end computer next time around and have the same quality you had with the high-end one and actually lower your costs without lowering your standard of living. Likewise, if quality extends the life of a product, you may not buy it as often, so how it is weighted as a cost of living should change. (I agree that quality changes need to be factored in somehow; but I’d argue that it is typical in my experience that the consumer has to buy things more often because they become obsolete faster (and, so, stop working with other things) or because the quality goes down so they don’t last as long.)
• New products do not get added to the government basket until they become commonplace. Therefore, changes in their prices don’t get included for some time. (I’d argue, Why should they be included? They only become part of the average cost of living when they become commonplace enough to affect the average person.)

So, that in short form is how the US government was able to announce in September there was no inflation over the course of the past year and, therefore, was able to decide there would be no needed rise in Social Security benefits in the year ahead … even though you look at your bills and see higher prices for almost everything. You KNOW your out-of-pocket expenses have gone up more than either the government or the Federal Reserve say they have.

As for the Federal Reserve, it has a mandate to keep inflation at or below 2% annually. Since inflation eats away annually at the value of bank assets, such as the mortgages banks hold, which get paid back in dollars that are worth less and less than those that were loaned out, and since hyperinflation causes runs on banks, the banks are afraid of rampant inflation. On the other hand, the banks that own the Fed have added a fortune to their wealth by creating money and giving it all to themselves to invest in stocks and bonds. The size of their stock purchases alone is enough to drive the value of stocks up.

They have a huge incentive to keep the presses rolling so long as there does not appear to be any hyperinflation resulting. Being almost human, bankers’ greed may cause them to keep the presses running longer than they should because they just hate to turn that money off. If it suits them to keep creating money and giving it to themselves, they have incentive to see the US inflation rate tweaked downward from reality. I’m not saying they would ever do such a thing; but they have created ways of factoring certain items back OUT of CPI that they don’t think should be included, which helps keep down the inflation rate they go by.

More reading on the US inflation rate:

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October 16, 2015 @ 3:13 pm

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