Economists have been reporting low rates of inflation all year – the annualized rate has been below 2.1 percent right through 2014, and has even dipped below 1.2 percent – but for many Americans it doesn’t feel that way. If inflation is so low, why is it a basket of groceries seems to cost so much more than last year, and why is there never any money left at the end of the month? The answer is that inflation isn’t really a good measure of what’s happening to the cost of living. To understand what’s really going on we need to look in a bit more detail.
Firstly, inflation is the big picture. What it measures is the purchasing power of the dollar right across the economy, in every sector. One common measure is the Consumer Price Index, or CPI. This is a hypothetical “basket” of goods, including food, consumer electronics and some services, which are priced at various key locations around the country then averaged out. An increase in the consumer price index is counted as a sign that a dollar now buys less, and that fall in purchasing power becomes the rate of inflation. As a large-scale economic statistic it’s valuable – but for the average consumer it’s a long way from the whole story.
Because the CPI basket is designed to measure the economy as a whole, it doesn’t look much like what the average American actually buys in the course of a year. The biggest difference is the proportion of the basket devoted to categories of expenditure. For example say that two of the items in the basket are a can of beans and a color TV. The price of the beans goes up from $1.50 to $1.55, but the price of the TV drops from $499 to $429. That’s going to show a significant fall in the CPI. Does it also show a fall in the cost of living? No it doesn’t, because the average family buys a can of beans a lot more often than they buy a new TV.
Where the CPI falls down as a measure of the real cost of living is that it doesn’t prioritize spending or allocate goods the way a real household does. It just compares a range of prices to see if they’ve gone up or down. When the things people buy rarely are getting cheaper, but the things they buy every day are more expensive, cost of living rises even if the CPI shows inflation being low. That’s the situation the USA is in right now. A lot of luxury goods – especially electronics – are getting cheaper, as they have been for years. However many essentials now cost a lot more than they did just a year ago, with food and property rental being tow of the biggest climbers.
It’s obvious that these increases in living costs are going to hit the working and middle classes hardest, because spending on essentials is going to eat up a larger part of their income. Just to make matters worse, for most people their wages haven’t even been keeping pace with the official inflation rate – never mind the true increase in the cost of living. The Bureau of Labor Statistics found that wages in the first quarter of 2014 hadn’t risen at all over the previous year’s figure even though the CPI was up by 2.1 percent. With food and rental inflation running at two or three times that figure it’s no wonder things feel a lot tighter than they did a year ago.