Should you believe the government’s inflation figures?

Every month, the US Bureau of Labor Statistics publishes inflation numbers for the previous month. And every month, bloggers go ballistic and tell us that:

–The consumer price index (CPI), which is used to measure inflation, doesn’t include food and energy prices. If you like to eat, drive, or heat your home, tough luck.

— The CPI assumes you will be just as happy substituting cheaper goods for less expensive ones if prices rise. Everybody uses exactly the same example for this: “If the price of steak goes up, the government assumes you’ll buy more hamburger, so there’s no inflation.”

— The government has a vested interest in depressing the “real” inflation number so it doesn’t have to pay Social Security recipients their promised cost of living increases, plus it can save on interest payments on inflation-protected bonds.

Is any of this true? And if it is, should you care? Is anybody checking the government’s work to keep them honest? And what should you be doing if you’re worried about inflation?

I’ve got my trenchcoat and magnifying glass right here.

Myths and facts

The two most common criticisms of the CPI are just plain false. There are actually several CPIs, but the two most important for the average American are the CPI-U, which is used to index inflation-protected bonds (also known as TIPS and I-Bonds), and the CPI-W, which is used for Social Security cost of living adjustments.

Both of these measures include food and energy. The CPI-U and CPI-W are up sharply over the last six months because of food and energy prices. If you receive Social Security, you will receive a cost of living increase this December (unless we hit major deflation between now and October, which is very unlikely). If you hold TIPS or I-bonds, you will get an inflation adjustment soon. This is not one columnist’s wacky opinion. This is verifiable fact.

As for steak and hamburger, as the BLS puts it, “Hamburger and steak are in different CPI item categories, so no substitution between them is built into the CPI-U or CPI-W.” So quit saying that. Please. Have a burger.

Who’s watching the inflation-watchers?

Okay, but maybe federal pencil-pushers monkey with the data in more sophisticated ways than handing you a burger and calling it steak. Wouldn’t it be great if someone without a vested interest was checking their work?

Since 2007, the Billion Prices Project (BPP) at MIT has been collecting price data the same way you and I do it: by going online. This is completely different from the BLS’s method, which is to send people out to stores to pull shirts off the rack and check the pricetag. (Can you even imagine having this job?)

The project monitors over 5 million prices in 70 countries, including the United States. One the project’s early successes was demonstrating that the government of Argentina was consistently understating that country’s inflation rate. “They actually fired people from the statistical office and they forced them to recompute a new inflation rate,” says Roberto Rigobon, an MIT management professor and cofounder of the BPP.

Rigobon doesn’t work for the US government and would become famous (as economists go) if he found them pulling the same kind of stunts. So what’s the verdict? “When you look at our statistics and the statistics of the BLS, we have roughly the same inflation rate,” says Rigobon. “The increase in our index is almost identical to the total increase of the BLS. If you stop the graph before March, you would say, oh, the BLS is lying. You have no idea how many blogs I have to deal with.” Then March’s official numbers came in and confirmed what the BPP had been showing: prices are up.

“The BLS caught up with our number,” says Rigobon, laughing. “That’s putting it in an arrogant way.”

Another view

In 2010, Boston University professor Zvi Bodie teamed up with colleagues at the Federal Reserve to investigate claims of bias in the CPI. (The Federal Reserve, I should point out, has nothing to do with calculating the CPI.) “We found no evidence of manipulation,” says Bodie. “I don’t say that it’s a ridiculous thought. It’s just there’s no evidence of it having happened in the past.”

Here’s another piece of evidence. What if there were a political action committee made up of older Americans, people who receive Social Security, who turn out to vote in every election, and have lots of spare time to call and write their elected representatives? If, hypothetically, there were such a group, how loud do you think they would be screaming about CPI bias?

Well, this is what the AARP has to say about the CPI in a recent policy paper: “The CPI-U and CPI-W are thought to overstate inflation[.]” Overstate!

But let’s say for the sake of argument that Bodie and the AARP and the BPP are wrong, and the BLS has been systematically underreporting inflation for years. Who cares?

If you’re receiving Social Security or have a job with pay indexed to the CPI, you care a lot. But nobody else should care at all. You care about the actual inflation rate, not what someone says it is. If it’s rainy and I tell you it’s sunny, I’m a jerk, but it doesn’t affect whether you get wet.

So regardless of whether the government publishes real or funny numbers about inflation, you’ll want to carry an umbrella. What does an inflation-fighting umbrella look like?

Inflation fighters

The two most common and most effective ways to weather inflation are:

Have a job. No, your salary doesn’t adjust to the prevailing inflation rate from day to day. Over time, however, it does. (Or, if it doesn’t, you’ll look for a new job.)

Have a fixed-rate home mortgage. If you owe money, inflation is your friend, because if dollars are going to be worth less tomorrow, so is the principal on your mortgage and so is your monthly payment.

You can find a million articles about “inflation-proofing” your investment portfolio. But if you’re still in the workforce, your portfolio is already resistant to inflation, because your monthly contributions will (or should) rise with your salary, and because both stocks and bonds tend to outpace inflation over time. (Like all investment rules of thumb, of course, this one comes with no guarantee.)

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.