inflation is a common topic on these threads because it is an economic indicator and also important when storing wealth. however how accurate or even relevant are the methods of calculating inflation? the two main methods are the paasche and laspeyre indexes. but do they take into account the true value of inflation and if they don't then what should the interest targets have been based on. has inflation even been set at the correct target over the last twenty years? i think not. it concerns me how house prices are not represented in the cpi as thoroughly as the rpi and even then their not truly shown. i watched bbc parliament recently and lord saatchi gave an interesting and convincing argument that inflation is not calculated well. if i recall he believed that the heart of the loose monetary policy is down to this incorrect inflation calculation. but what is the alternative, perhaps a real time pricing mechanism that alters the prices for assets instantaneously through an national database but would that prevent small trade from being included? what do you think or suggest? SORRY I HAD TO REPOST IT DIDN'T MAKE SENSE ORIGINALLY. SOMEONE WAS TALKING TO ME WHEN I WROTE IT.
I suggest going to the grocery store. Buy all your food, keep the reciept. Next month, buy all the exact same items. Compare reciepts. Theres your inflation. At least to where it really matters. If you want a broader market...go to wal-mart and look at the prices of some of the things. Write them down and check them in a month. Theres your inflation also.
http://www.shadowstats.com/article/consumer_price_index Inflation should be at least twice as high as recorded (cpi) over the past 20ish years. Main reasons: 1) Switch from arithmetic to geometric weighting was done simply to mathematically reduce any increase in the cpi over time. 2) The "Quality adjustments" that were also introduced ~ 20 years ago --> "If a consumer switches from a $20 steak to a $5 hamburger, there surely has been deflation!!" 3) House prices. Only the change in interest payments on mortgages is included in the cpi. The truth is that buying a house is not an investment; the value of a house should (theoretically) not increase at a rate any faster than that of the economy. The meteoric rise in house prices due to lax lending, low interest rates and government intervention has represented a real source of inflation over the past 20 years. New home owners have to save for an entire year just to make a miniscule down payment on a house now.
In the UK, as the OP mentioned, house prices do form a part of RPI (under the Depreciation component and it's not that bad of a measure, actually), but not CPI. Given the scrutiny RPI receives, the number of wage deals (esp public sector) still tied to RPI and the fact that the inflation-linked gilt mkt is based on RPI, rather than CPI, I think UK has actually done relatively well. I agree that in the US the OER measure is a complete joke, which definitely contributed to the creation of the bubble.
great answers, thank you and thanks for the links too. the thing i am concerned about is the relationship between interest rates and inflation. if the interest rate is used to provide a return and is based on the inflation figure (to calculate the base rate) and the inflation figure is lets say half of what it should be. that would mean people are not really making any return if that continues and people appreciate that then they may start investing in other areas, but where and also if there is less investment in credit the constraints will get worse and economic recovery is far harder, where will the new investment come from when the fiscal stimulus is over? lots of questions can be raised as to how a free market can be maintained when these fundamentals of economic logic are no longer in place. what is going on?
Inflation is grossely understated imo. I live in europe and the cost for say drinking a coke in the pub has tripled at least since the euro was implemented and this was a decade where the euro was amongst the best performing currencies across the globe.