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Is inflation understated?

The Consumer Price Index is a measure of the change in prices consumers pay for different goods over time. This index is often used as a benchmark for inflation. However, the inflation levels the Consumer Price Index suggests are not without controversy. Often inflation is accused of being overstated or understated. So what is the truth? And why would it be either?

No, inflation is overstated

Various biases cause inflation to be continually overstated.

Shift in what is relevant to the CPI

Technological change means that many things we used to pay for are now free. Explore

Rise in quality causes inflation to be overstated

Quality improves over time, and adjusting for quality means consumers get more for less. Explore

A 'theoretical fixed basket' doesn't reflect what people buy

When prices rise, consumers buy cheaper goods rather than higher priced goods. Explore

Inflation is accurate, but ignores varying demand elasticity among its components

The fastest-inflating components of CPI are demand inelastic. You can delay or decline a TV purchase, but not a hospital stay. Demand-inelastic items therefore consume an ever larger proportion of the consumer budget. This is most noticeable to lower-income consumers, who perceive a creeping loss of financial control, even if their total spending is growing only slowly.

Yes, inflation is understated

The government has a vested interest in inflation being understated, and the data it is based on it largely theoretical.

The Government ensures inflation is understated

The government has a vested interest in understating inflation because payments are tied to it. Explore

Quality adjustments cause inflation to be understated

Quality adjustments may account for improvements in standards of living, but the consumer doesn’t pay lower prices. Explore

Inflation is multi-dimensional.

Representative basket of goods varies by geography and income bracket. There should be thus multiple inflation numbers reflecting this. Explore

Inflation indices do not reflect reality

Much of the inflation basket is theoretical and not based on increases in price. Explore

This page was last edited on Wednesday, 12 Aug 2020 at 14:03 UTC

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