Inflation Adjustments

Throughout this website, we avoid using “Real” or inflation adjusted data. There is a reason for this. To make accurate decisions, one must have accurate data. Inflation adjustments are inaccurate estimations. Including them in calculations guarantees inaccurate decision tools.

These indexes are flawed because they do not account for technological advancements. Making this less theoretical, Frugal Ron had a 30-year-old Maytag washer that finally died. While he had the Maytag, Frugal Ron spent most of his weekends hanging around the house and every hour or so stuffing a different set of dirty clothes into the washer.

New washers provided a good dose of sticker shock. But, Frugal Ron’s biggest surprise was the amount of clothes he could put into the new unit. Before noon on Saturday, the laundry was finished.  He literally didn’t know what to do with the rest of his weekend.

While economists calculating the Consumer Price Index (CPI) were noting the inflationary impacts of clothes washers on the economy, they couldn’t measure the impact these new generation units have on people’s lifestyles. The list goes on, cars we drive today are safer, use less fuel and have more amenities. New products such as microwave ovens offer a new level of problems in calculating CPIs. These items typically are more expensive and overestimate inflationary impacts because there is no countervailing measure of their utility to users.  This inaccuracy is acceptable when making one or two year adjustments but is compounded when used over longer periods. For example, attempting to adjust a 1930 automobile’s price into today’s dollars provides entertainment value but is not a decision-making tool.

Another problem with inflation indexes is people’s propensity to assume an inflation index can be extrapolated on a range of products that is broader or more specific than it was calculated for.  The Consumer Price Index produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.

Using the CPI and adjusting the federal government’s annual spending for inflation gives you a number; it does not give you accurate information. Typically, family market baskets don’t include new generation stealth airplanes and ships nor do they include subsidies for farmers and highway construction. “Chained 2005 Dollars” and other measures have similar issues.

On a more technical track, the “Percent Change from Preceding Period in Real Government Consumption Expenditures and Gross Investment” calculated by Bureau of Economic Analysis is incorrectly used to adjust all government expenditures. This value only includes adjustments for goods and services included in our Gross Domestic Product. For example, “Current transfer payments” of $2.3 trillion are not included and Grants In Aid and Social Benefits are not available or aren’t really defined.

Since there isn’t an accurate way to adjust government spending or receipts for inflation, nominal values are used throughout this website. Granted, this isn’t perfect but it is Frugal Ron’s judgment call that nominal values used consistently provides more accurate decision making data than any other methodology.

Inflation does exist and Frugal Ron is making no effort to discount is impact on data. You will notice creative ways to minimize inflation’s impact throughout this website’s analyses.

www.frugalron.com 2012


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