CPI looks at RENTS, not housing prices as its measure of housing costs.
The government's calculation of core inflation excludes items such as food and energy, because food and energy "face volatile price movements."
My stomach "faces volatile movements" too :new_2gunsfiring_v1: looking at the continuing increases in price of Food and Gasoline.
The CPI index was changed to equivalent rents from actual home prices back in the 1980's to help solve the Social Security solvency problem.
The government reconstructed the housing "price" component (40% of the CPI) to utilize "rents" to calculate housing costs. This eliminated soaring housing prices not to mention property taxes from the calculation. And, since home ownership as a percentage of housing units has risen since then, the effective CPI is understated severely.
Changes made in CPI methodology during the Clinton Administration understated inflation significantly, and, through a cumulative effect with earlier changes that began in the late-Carter and early Reagan Administrations have reduced current social security payments by roughly half from where they would have been otherwise.
In the early 1990s, press reports began surfacing as to how the CPI really was significantly overstating inflation. If only the CPI inflation rate could be reduced, it was argued, then entitlements, such as social security, would not increase as much each year, and that would help to bring the budget deficit under control. Behind this movement were financial luminaries Michael Boskin, then chief economist to the first Bush Administration, and Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System.
Although the ensuing political furor killed consideration of Congressionally mandated changes in the CPI, the BLS quietly stepped forward and began changing the system, anyway, early in the Clinton Administration.
Up until the Boskin/Greenspan agendum surfaced, the CPI was measured using the costs of a fixed basket of goods, a fairly simple and straightforward concept. The identical basket of goods would be priced at prevailing market costs for each period, and the period-to-period change in the cost of that market basket represented the rate of inflation in terms of maintaining a constant standard of living.
The Boskin/Greenspan argument was that when steak got too expensive, the consumer would substitute hamburger for the steak, and that the inflation measure should reflect the costs tied to buying hamburger versus steak, instead of steak versus steak. Of course, replacing hamburger for steak in the calculations would reduce the inflation rate, but it represented the rate of inflation in terms of maintaining a declining standard of living. Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food after that.
The BLS initially did not institute a new CPI measurement using a variable-basket of goods that allowed substitution of hamburger for steak, but rather tried to approximate the effect by changing the weighting of goods in the CPI fixed basket. Over a period of several years, straight arithmetic weighting of the CPI components was shifted to a geometric weighting. The Boskin/Greenspan benefit of a geometric weighting was that it automatically gave a lower weighting to CPI components that were rising in price, and a higher weighting to those items dropping in price.
Once the system had been shifted fully to geometric weighting, the net effect was to reduce reported CPI on an annual, or year-over-year basis, by 2.7% from what it would have been based on the traditional weighting methodology. The results have been dramatic. The compounding effect since the early-1990s has reduced annual cost of living adjustments in social security by more than a third.
Changes estimated by the BLS show roughly a 4% understatement in current annual CPI inflation versus what would have been reported using the original methodology. Adding the roughly 3% lost to geometric weighting - most of which not included in the BLS estimates - takes the current total CPI understatement to roughly 7%.
Although the CPI is not used in the GDP calculation, there are relationships with the price deflators used in converting GDP data and growth to inflation-adjusted numbers. The simple truth is that the GDP growth is overestimated by understating inflation.
It is no wonder that the public sentiment concerning the economy believes it is worse than it is. That because it is and has been under performing the published growth. Wages and benefits are not keeping pace with inflation. The Boskin/Greenspan argument of substitution for price increases does in fact have it application through [SIZE=-1]
globalization[/SIZE]. The cost of goods and services along with labor can be replaced with cheaper goods and services and labor in the international trade economy.
There is a lot more to the big lie of inflation, government statistics and economic policy. But that will be talked about at another time.
And if this is not enough to worry about, guess who will control all three branches of government while this is all unfolding? 