Earlier in the year, the Wall Street Journal Online published a great piece on why the “official” inflation numbers are probably skewed. All of the adjustments to the calculation of CPI over the last 30 years have made CPI seem “more bearable”.
Two areas that I think are of major concern in the calculation are the principles of substitution and hedonics. Substitution simply states that when the cost of fresh vegetables creeps to high, the government calculation assumes you buy canned veggies—and thus any additional inflation on vegetables is avoided. Hedonics attempts to value a product based on the values of its underlying constituent parts—the best example is a piece of technology. CPI takes into account that if the same technology is the same today as it was three years ago, that the product has experienced negative inflation (deflation) due to the fact that the parts used in today’s model are better or more efficient. I will let you judge whether that argument has merit or not.
The bottom line is that the calculation of CPI is constantly changing, and at the suggestion of one “rogue” economist John Williams, if we still calculated inflation the way we did when Jimmy Carter was president, the official rate wouldn't be current CPI of 3.7%--it would be closer to 10%. These factors tell you how central a concern that inflation should be in the financial planning discussion.
