The consumer price index (CPI) guides markets and motivates policy, but it is nothing more than speculation, estimates and wild guesses.
A recent “adjustment” to the health insurance CPI reveals that the formula is, in fact, a scam.
As I have emphasized time and time again, the CPI generally underestimates rising prices. The formula is designed for that, and in the 1990s the government made it worse.
In 1998, the Bureau of Labor Statistics (BLS) followed the recommendations of the Boskin Commission, a committee appointed by the Senate in 1995. Initially it was called the ‘Advisory Committee on Studying the Consumer Price Index’. Her job was to study possible biases in the calculation of the CPI. Unsurprisingly, it found that the index overestimated inflation – by around 1.1% per annum in 1996 and around 1.3% before 1996. The 1998 changes to the CPI were intended to address this ‘problem’ pack by making sure the formula consistently spit out a smaller number.
In fact, the government has cooked the books.
If we used the 1970s formula today, the CPI would roughly double.
That is not to say that the 1970s formula accurately reflected rising prices. The whole process is suspect. The BLS incorporates all kinds of geometric weightings, substitution and hedonics into the calculation. By manipulating the numbers in the formula, the government can essentially create an index that produces whatever it wants.
A closer look at how the BLS calculates rental costs sets a good example.
The owner’s equivalent rent should reflect the amount a homeowner would have to pay in rent to live in the same home. The Bureau of Labor Statistics determines this number in a survey, asking homeowners, “If someone were to rent your house today, how much do you think it would rent monthly, unfurnished and without utilities?” It is literally nothing but the homeowner’s opinion. It has virtually no correlation to the actual cost of the house.
In fact, during the early stages of the last surge in price inflation, the CPI showed only modest rent increases, even as real rental costs soared.
THE HEALTH INSURANCE DEBACLE
In October, the BLS made an adjustment to the CPI formula for health insurance, resulting in a 1.1% increase in health insurance costs. That’s a significant jump, but it wouldn’t surprise anyone who has recently priced health insurance.
But the dirty little secret is that the BLS made the adjustment because the old formula reflected a 37% drop in health insurance costs between September 2022 and September 2023. During that twelve-month period, the cost of health insurance fell by a quarter, according to the CPI. an average of 4% per month. As a result, the CPI of health insurance fell to the 2018 level.
Does any sane person in the real world think that health insurance costs have fallen 37% in the last year?
Of course not!
This means that the monthly CPI and core CPI have been significantly undervalued for twelve consecutive months, and the annual figures will continue this distortion into the following year.
But do not worry; the BLS “fixed” the problem. In October it introduced changes that will increase the CPI cost of health insurance over the next 12 months. The small upward check mark on the right side of this diagram shows the first adjustment.
If WolfStreet put it“The BLS has made the health insurance CPI a chicken st!t.”
This is what happened.
This ignominious fiasco of a key metric within the CPI data occurred because the model the BLS used to estimate health insurance CPI – the “retained earnings method” – after working reasonably well for years, blew up amid the disruptions and cash flows during the pandemic.
“Rather than immediately come up with an alternative estimate in 2021, when these problems became apparent, the BLS let this fiasco drag on for two years, overestimating 2022 health insurance inflation by a modest amount, causing the health insurance CPI to simply collapse . over the past twelve months through September 2023, back to 2018 levels.”
And this was just an adjustment. The BLS has not revised the formula. It continues to use the same “retained earnings” method that blew up in 2020.
If the BLS has screwed up so badly for health insurance, why should we believe what it tells us about the cost of food, energy, or anything else?
This debacle exposes the sham that is the CPI. It is disconnected from reality. And yet economists, financial analysts and policy makers treat this data as if it were handed down from heaven on tablets of stone.
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