Today's question: The high rate of inflation today is principally in energy and housing. I own my own home and use relatively a small amount of energy products. If I am not buying something subject to inflation, does inflation affect me?
Yes, it does, but much of the effect will be indirect and far smaller than the various inflation indexes would suggest. In addition, inflation may affect the amount of wealth you have, not just your current purchasing power.
The rate of inflation depends, of course, on which price index one uses to measure it. During the past year some of the measures have diverged widely.
The one most often quoted in news stories is the consumer price index, or CPI. Between October 1978 and October 1979, the CPI rose 12.2 percent. cAs of October 1979, the index stood at 225.4, which means it took $22.54 to buy exactly the same goods and services it took $10 to buy in 1967.
And therein lies one major problem with the CPI: It is based on a fixed-market-basket concept, on the implicit assumption that the urban consumers on whose buying patterns it is based all buy the items in that market basket in the same proportion all the time. In short, the CPI is an average that fits no consumer's situation exactly.
The statisticians who created the index know that, of course. But an alternative index giving the same useful detail that also incorporated month-to-month changes in consumer buying patterns would understate inflation to some extent because it would be influenced by consumers switching to lower-priced products. That is precisely why the CPI relies on that fixed market basket.
Such an index, which is similar to one the Commerce Department has just begun publishing monthly, still represents an average for all the consumers in the group. Someone who only drove a car a few miles a week would be affected quite differently by a big jump in gasoline prices than someone driving 100 miles a day.
The CPI assumes consumers do not switch products when the price of one brand increases rapidly or another goes on sale, and it doesn't reflect these changes when they occur.
Similarly, consumers frequently switch to ready substitutes when prices change. Many times over the years, for instance, they have purchased pork or chicken instead of beef when beef prices took off. That is not a switch to an identical product, of course, but many consumers might not feel any particular loss of welfare is involved.
Some statisticians also think the CPI overstates inflation by not giving enough credit to quality improvements in some to the products actually priced each month. They often cite automobile tires as one example.
presidential inflation adviser Alfred Kahn recently has complained bitterly that inclusion of mortgage interest rates in the CPI exaggerates the reported rate of inflation. If they were not included, the CPI would have risen 10.9 percent in the latest 12 months instead of 12.2 percent. In the last six months, the CPI has gone up at an annual rate of 14.7 percent, but only at an 11.9 percent rate once mortgage interest cost are taken out.
Some homeowners still are paying off 6 percent or 7 percent mortgages incurred years ago. Naturally they haven't been affected much by the recent rise in rates to record levels -- unless they have had to put off purchasing a new home or refinancing their present one because of the level of mortgage rates. Inflation, after all, can take its toll by discouraging a purchase as well as by putting a hole in one's wallet after it has been made.
But few mortgages ever run their 25-year or 30-year term. On average, they are paid off when the house is sold or refinanced within about five years. Thus, inclusion of a mortgage interest factor in the CPI cannot be dismissed as nonsensical. It is a price change which affects comsumers more frequently than most people realize.
Inflation is affecting homeowners in other ways, too. The surge in sale prices of homes increases both the wealth of homeowners and their property taxes. Inflation has similar effects on owners of some cars, both very expensive models and lower-priced ones that are highly fuel-efficient.
Even those consumers who aren't buying products whose prices are rising rapidly may be affected by that component of inflation. For example, increased gasoline prices affect the price of many other goods because businesses making, transporting and selling those goods raise their charges when fuel costs go higher.
The cost of gasoline still can affect someone who uses little of it.
Nevertheless that index won't describe accurately the effect on inflation on any consumer who does not buy the same things that are in that CPI market basket. the effect of inflation on someone who recently bought a house heated with oil and financed by a 12 percent mortgage and who must drive long distances to work each day in a gas guzzler would be far worse than the CPI would indicate.
In a number of ways, the best measure of the impact of inflation on consumers is the new Commerce Department index known as the personal consumption expenditure deflator. Commerce produces this index in connection with tracking changes in the nation's total output of goods and services, or the gross national product.
The PCE deflator, which has just become available on a monthly basis, measures the increase in cost of the goods and services consumers actually bought that quarter. Between September 1978 and September 1979, it rose 9.4 percent compared with the CPI's 11.8 percent increase.
Because of the distortions arising from including mortgage interest and home purchase prices in the CPI, the PCE deflator is probably a better measure of the impact of inflation on the average consumer.But it has the same problem as the CPI in that it is still an average, and who wants to think of himself or herself as average even in spending habits?