Beyond the Basket: Some Thoughts About Inflation

When you’re visiting a new city, it may take a little while to catch on to the directions people provide. Are all those tall buildings uptown or downtown? Until you’re familiar with the local shorthand, you may have trouble keeping up.

There are many types of ‘shorthand’ in common use, for example, the Federal Reserve Board uses the Consumer Price Index (CPI) as a shorthand measure of inflation while following its mandate to keep it under control. The Bureau of Labor Statistics (BLS) regularly updates the CPI and publishes a monthly report that the Fed (and many others) watches closely. An unexpectedly small or large change in the report can be counted on to provoke sudden moves in the stock and bond markets.

The CPI tracks changes in the cost of a ‘market basket’ of goods thought to be representative of items consumers regularly purchased in seventy-five urban areas. The BLS’ methodology seems sound, and the CPI does a good job of painting a broad picture of overall inflation across the country. What it does not do is capture inflation as experienced by any specific family, including your own. There are several reasons for this.

• The CPI focuses on urban dwellers which makes sense from a data-collection perspective but generally ignores the spending of those living in smaller communities.
• The contents of the ‘market basket’ are rarely changed in hopes of maintaining consistency. However, spending habits do change, tending to move to cheaper substitutes with rising prices and purchasing more premium items as prices fall.
• The CPI can’t track improvements or declines in product quality. Technology has made many electronic items less expensive while durable consumer products have become less reliable in recent years and more likely to need replacement.
• As inflation has risen, many consumer products now come in smaller quantities. A pound of butter still weighs 16 ounces but most bags of ground coffee, once a pound, now weigh only 12 ounces. The BLS has difficulty accounting for this effect, often referred to as ‘shrinkflation.’

In addition to the challenge of measuring inflation objectively, its effects are experienced differently depending on individual situations. For instance, if you are retired you may live in a house with a paid-off mortgage and rooms full of furniture, so credit card and mortgage interest rates are not a major concern. However, you may frequently have to contend with rising healthcare costs. Conversely, if you are still working, you generally spend less on healthcare but are often paying more for air travel and children’s college education, while simultaneously needing to fund your own retirement.

DCM can create a custom financial plan to respond to each client’s ‘personal rate of inflation’ before turning to our range of investment strategies. While there’s no harm in reading the CPI press releases, please don’t let the headlines concern you. You can always contact your DCM team for reassurance that your plan remains on track.