San Diego Union-Tribune - April 17, 2008

The Fed's inflation gauge isn't realistic, critics say

By Dean Calbreath

ou've seen the cost of a gallon of premium gas breach the $4 mark at local stations. You've seen the price of milk, eggs, corn and bread surge at your supermarket. Yesterday, the government confirmed that prices are continuing to rise at a very brisk pace.

In March, consumer prices rose 0.34 percent, for an annualized rate of more than 4 percent, according to the U.S. Department of Labor. That's only slightly lower than the 2007 annual rate of 4.1 percent – which was the highest inflation rate this decade.

On the other hand, so-called core inflation – which excludes energy and food prices because they are considered volatile – rose only 0.15 percent, or 2.4 percent over the past year, which is close to the Federal Reserve's 2 percent comfort zone.

For the Federal Reserve, the core inflation rate amounts to a green light to continue its policy of lowering interest rates in order to keep the economy from falling into a deep recession. A higher inflation rate could conceivably make the central bank freeze or raise interest rates.

But many economists say the core rate does not show how inflation is affecting the typical consumer. Because salary raises for most people are not keeping pace with the rising cost of living, people are using a greater percentage of their wages to buy a smaller amount of goods.

“Food prices and the price of gas are really eroding the purchasing power not just of the working class, but people in the middle class, who are already beginning to have a hard time making ends meet,” said business-trend consultant Joel Kotkin.

John Williams, who spent more than two decades as an economic consultant to Fortune 500 companies, said the government figures understate the true rate of inflation.

Williams, who runs Shadow Government Statistics in Oakland, which tracks changes in inflation, unemployment, the gross national product and other data, said that over the past 25 years, the government has changed the method of calculating price increases in ways that have lowered the reported inflation rate.

The changes include measuring the cost of shelter by rental prices instead of home values, as well as giving nearly as much weight to high-ticket items such as cars and electronics as to daily necessities such as food and gasoline.

According to Williams, if the government measured inflation based on pre-1982 methods, it would be running at 11.6 percent right now, or 7.3 percent using pre-1998 calculations.

“I don't think the government numbers are too credible,” Williams said. “When they say food inflation is moving up by 0.2 percent, that just doesn't match what we're seeing in the market. But even if inflation is as low as they are reporting, it's high enough to be terribly destructive to the economy.”

A number of other analysts echo that viewpoint. Rudolph-Riad Younes, co-manager of the Julius Baer International Equity Fund, estimated in December that inflation was running at 8 percent to 10 percent.

San Diego investment guru Richard Russell said in a recent newsletter that the Federal Reserve “makes up its own inflation figures. True inflation is running wild.”

Other economists are skeptical of such claims. James Hamilton, an economist at the University of California San Diego, said changes in the inflation rate over the past 25 years “don't represent huge differences” from the way overall inflation is currently measured.

On the other hand, Hamilton said he does “not take too much comfort in the core inflation rate.” He noted that food and energy prices have been rising steadily for several years and that polls show consumers now expect inflation to continue rising at more than 4 percent.

“I would think that would really be troubling to the Federal Reserve,” Hamilton said.

Economists say inflation has forced consumers to cut back on the goods they are buying.

“Everybody's cutting back and getting squeezed in one way or another,” said Michael Belch, a marketing professor at San Diego State University. “If you're a blue-collar worker paying more and more for gas so you can drive to work each day, there comes a point where you become inelastic, and you have to start deciding there are things you just can't spend money on anymore.”

Nearly 56 percent of Americans believe their current economic standard of living is declining, according to a national poll this month by the Sacred Heart University Polling Institute in Connecticut. That number is up from 24 percent in 2006. Only 38 percent of respondents said their standard of living is improving, compared with 72 percent in 2006.

“Clearly, the crisis in the credit markets coupled with significant increases in not just gas but also food have combined to make the average American feel poorer and pessimistic about the future,” said John Gerlach, an associate business professor at Sacred Heart.

In high-cost areas such as San Diego County, the effects of inflation are even more pronounced, since prices often rise faster than local salaries.

Although the Labor Department does not release monthly data on regional inflation, its annual data show that in the past five years, consumer prices in the county have jumped 22 percent, compared with 16 percent nationwide.

“The three main reasons were our housing prices, gas prices, and electricity and utility rates, which were all rising faster than the national average,” said Kelly Cunningham, an economist with the San Diego Institute for Policy Research.

Thanks to the softness in the county's housing market, inflation softened last year to 2.3 percent, compared with the national rate of 3.1 percent.

Recently, the primary driver of inflation – both in the nation and the county – has been the rising cost of fuel.

In San Diego County, the average price of a gallon of regular gasoline rose 18 percent, from about $3.23 in March 2007 to $3.83 on Monday, according to the Utility Consumers' Action Network, which tracks fuel and utility prices.

The rising price of fuel has pushed up other items as well, notably food, which depends on oil for transportation, cultivation equipment and fertilizers.

Since last March, the price of eggs has gone up 35 percent; bananas, 17 percent; bread, 16 percent; apples and chicken, 10 percent; and ground beef, 7 percent, according to Labor Department data.

These price rises have been particularly hurtful to people living on fixed incomes – including the elderly – since their government-provided benefits are lagging behind the rising costs. Social Security and other government benefits are tied to the official inflation rate.

“Inflation is really hurting seniors, because they're on fixed income and food is costing more and more,” said Father Joe Carroll, who runs the Father Joe's Villages charitable organization.

Carroll said inflation is wreaking havoc with his own budget because – among other things – the rising price of gasoline is adding to his costs of transportation and picking up donations of furniture and clothing.

“Everything we're looking at is going up,” Carroll said. “Inflation and the downturn in the housing market (are) having a huge impact on us. I've been working all day looking at ways of cutting my budget. For the first time in 25 years, I'm thinking of cutting programs.”

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