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Inflation and the Billion Prices Project

Written by Nickel - 4 Comments

Inflation and the Billion Prices Project

When it comes to planning for your financial future, inflation is a huge issue. In fact, given the historic annual inflation rate of 3.75% a million dollars today will be worth just over $190k in 50 years. Moreover, using that historic rate along with the rule of 72, we can further conclude that prices will double every 19.2 years.

CPI vs. the true cost of living

Of course, it’s also been argued that the true cost of living is increasing faster than the official inflation rate. One problem is that gas and groceries are omitted from the so-called “core inflation rate,” meaning that when food and fuel prices spike, this particular inflation indicator might not budge. For this and other reasons, it has been argued that official inflation estimates understate the true situation.

The motivations for underestimating inflation are obvious. Because numerous governmental programs, as well as estimates of “real” economic growth are indexed to inflation, the federal government can (at least in theory) save money and paint a rosier economic picture by understating inflation. I’m not going to wander of into the weeds and debate whether or not this is happening. Rather, I’m just pointing out the potential benefits of inflation manipulation.

Note: Just to clear up any confusion, inflation-indexed government programs typically use the CPI-U, which does include food and fuel prices. The point here was just that, for a variety of reasons, the various inflation estimated have been criticized as inaccurate, with a tendency to understate the real situation.

If inflation were to be understated, however, this would be a huge deal from an investor’s perspective. After all, if you think that inflation is running at X% and it’s really running at Y% (where Y > X), then you’re likely to fall well short of your goals – at least in real terms. The reason for this is that, even though your portfolio may be growing, the value of each dollar is shrinking faster than you expected.

Estimating inflation in the real world

With that as a backdrop, I wanted to point out an interesting website that I ran across this past weekend. It’s called The Billion Prices Project (BPP). The BPP is an academic project based at MIT which seeks to use prices collected at hundreds of online retailers to estimate a daily price index.

As of now, they are still well short of covering all of the goods and services that go into the CPI. If you click through and look at the graph, you’ll see that there is a rough correlation between the BPP index and the CPI. Since late 2009, however, it appears that the BPP index has been running ahead of the CPI.

Given the differences in what the two indices cover, it’s difficult to say if this difference is real, but this is (to me at least) a fascinating project with a lot of potential. It would be great if they can tweak the BPP to the point that it converges on the CPI. It would be especially nice to see a real-world calculation that includes the cost of fuel.

While fuel prices aren’t easy to come by online, and thus aren’t part of the BPP index, it seems like they could partner with a crowd-sourced database such as Fuelly (which I’ve written about before) to get real-time estimates of fuel prices from throughout the country.

Published on May 25th, 2011
Modified on May 30th, 2011 - 4 Comments
Filed under: Economy, Online, Planning, Retirement

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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4 Responses to “Inflation and the Billion Prices Project”

  1. 1
    Jeff Says:

    You are confusing “core” CPI with CPI-U. While “core” CPI ignores volatile categories such as gas and food prices, the CPI-U, which is used by all prominent government legislation. While “core” CPI often gets a lot of play in the news, the only time it is really used by the government is by the Federal Reserve when making monetary policy decisions, although it has begun using other metrics as well to attempt to approximate inflation. The belief that the CPI used by your “numerous government programs” ignores gas and food prices is mistaken. Whether or not CPI-U actually matches your personal inflation is still a good question, but please do not further the misunderstanding between the uses of “core” CPI and CPI-U.

  2. 2
    jim Says:

    THe inflation index excluding food and energy is NOT tied to any laws and is not used to adjust any official governmental payments. Government programs are based on the \\\’all items\\\’ index that includes food and gasoline. This is a big reason why social security got a big fat increase in 2008 and zero increase in 2010, because of the volatility of gasoline impact on the CPI.

    ref :
    http://www.bls.gov/opub/focus/.....i_1_15.htm

  3. 3
    Nickel Says:

    Jeff and Jim: Poor wording (and word flow) on my part. I didn’t mean to imply that all of these things are influenced by core CPI – as evidenced by my previous post where I illustrated how to calculate savings bond rates using CPI-U numbers. Rather, my point was that: (1) inflation measures in general are imperfect, (2) they have come under fire from some corners as being unrealistic (yes, even CPI-U), and (3) there are definite benefits to understating inflation – unless you’re an investor.

  4. 4
    jim Says:

    The article talked about gasoline being ommited from ‘core’ inflation then goes straight into discussion of why government might underestimate inflation. Seemed like you were saying that government excludes gasoline to short change people. It seems many people like to argue that the government is ignoring the cost of gasoline so that the government can screw people out of inflation adjustments. Its cynical speculation usually based on misunderstanding of how the inflation figures work and what they’re used for.

    I agree that inflation measures are not perfect. I don’t agree with the idea that the government data inflation is flawed or wrong or somehow not as good as any other index.

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