By Alfred Tella
Published January 25, 2006/Washington Times
When the Labor Department reports on consumer
inflation every month, do you think the data should count items that consumers
don't buy or only items they do buy? If you say the former, you agree with how
the press reports the data. If you say the latter, you're right.
The featured price number that makes the monthly
headlines includes items that some consumers choose not to buy or to buy less of
because of changes in relative prices. For example, if steak gets pricey, some
shoppers will buy cheaper chicken instead. But such short-term shifts in buying
patterns are not reflected in the featured data.
The Labor Department also publishes in the same consumer
price press release an alternative series called the Chained Consumer Price
Index, which measures what people actually purchase, i.e., the index uses
weights that reflect substitution buying in response to changes in relative
prices.
Consequently, as is well known by economists, the
featured unchained price index is upward biased, whereas the chained index
paints a more accurate picture of consumer inflation.
On Jan. 18 the Labor Department reported in the opening
paragraph of its press release that the Consumer Price Index for All Urban
Consumers in December was 3.4 percent higher than a year earlier. This compared
with a 3.3 percent rise the previous year and smaller increases in the three
prior years.
The inflation story was widely reported in the media.
Here's a sample of newspaper headlines: "Prices Surged in '05" (The
Cincinnati Post); "Consumer Prices Rose by Largest Rate in 5 Years in
2005" (New York Times); "Inflation Hit Five-Year High of 3.4% Last
Year" (The Washington Post).
By comparison, the more accurate Chained Consumer Price
Index for All Urban Consumers in December 2005 was up by 2.8 percent over a year
earlier, a whopping 0.6 percentage point less than the featured number. Although
a 2.8 percent inflation rate is less than gratifying and above the Federal
Reserve's comfort range, its implications are a far cry from the misleading
message of alarmist headlines. You would be hard put to find any mention of the
chained index in the media inflation stories.
Nor was the preferred chained measure of consumer
inflation, unlike the unchained number, higher than in the previous year. The
2.8 percent year-over-year chained inflation rate in December 2005 was slightly
less than the 2.9 percent rate for the year before, again inconsistent with the
five-year-high inflation message of some major media headlines.
For the core inflation rate (total less food and
energy), the unchained series, at 2.2 percent, was the same year-over-year in
December 2005 as in December 2004, whereas the chained index increased more
slowly in 2005, by 1.7 percent December over December compared with 2.0 percent
in 2004.
The media have a responsibility to learn about the
economic data they report and interpret. Perhaps reporters should lunch more
often with economists. The reporting of economic statistics has consequences. It
influences people's behavior and expectations. It can affect work, spending and
saving decisions.
For example, if people are led to believe that inflation
is greater than it is and getting worse, they may try to beat expected future
price increases by spending more now. An advanced buying splurge could push up
demand thereby driving up prices and exacerbating inflation. Such behavior could
become a vicious cycle with escalating prices eventually ending in an economic
bust.
The Federal Reserve's worst nightmare is that price
expectations will become unanchored, leading to accelerating inflation. In that
event the Fed would have to raise interest rates sharply to fight the inflation,
thereby choking off economic growth and inviting recession. What the Fed doesn't
need, nor do the rest of us, is the major media sounding dissonant alarm bells
about current inflation based on second-best data.
The Labor Department also has the responsibility of
pointing out to the press the differences between the price indexes it
publishes, in particular their relative strengths and weaknesses. Similarly,
White House economists and the Fed need to be more vocal on the issue.
Fed Chairman Alan Greenspan has talked about the
superiority of chained prices indexes over unchained measures, but not loudly
enough. One hopes that Fed Chairman-designate, Ben S. Bernanke, currently
chairman of the President's Council of Economic Advisers, will emphasize the
point in the council's forthcoming annual report. The Congress should also be
asking questions, out loud.
If prominent government figures and the issuing
statistical agency lead the way, the press will follow.
Alfred Tella is a former Georgetown University
research professor of economics.