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Government's rosy data doesn't reflect real life

How can government data say inflation seems tamer when milk and gas both cost almost $4 a gallon? It makes you wonder if the government is performing a statistical sleight of hand.
/ Source: The Associated Press

If only beleaguered motorists and shoppers could make their gas pains and food sticker shock go away with the ease that the government can.

How can government data say inflation seems tamer when milk and gas both cost almost $4 a gallon? Wednesday's Consumer Price Index showed overall prices edging up a smaller-than-expected 0.2 percent even though food prices shot up by 0.9 percent, the biggest one-month gain in nearly two decades.

It makes you wonder if the government is performing a statistical sleight of hand. The same Labor Department report showed that gasoline prices fell 2 percent in April — after seasonal adjustments — when motorists were paying a lot more at the pump.

"Absolutely, it can raise suspicions. People don't pay seasonally adjusted prices. They pay regular prices. And for items that are purchased often like gasoline and food, they have a pretty good idea when those prices are going up," said Patrick Jackman, the Labor Department's head inflation counter.

While it almost looks like the government's number crunchers are cooking the books so that the politicians don't get blamed for soaring prices, the real answer lies more in economics than politics. It reflects how the Bureau of Labor Statistics goes about gathering and then presenting the thousands of prices of goods and services that it collects every month.

The BLS must not only check to see if a price has changed but also compare that change to what the price normally does for any given month — a process known as seasonal adjustment.

It was that process that turned a 5.6 percent rise in gasoline prices in April into a 2 percent decline.

The explanation: gasoline prices usually soar in April, the start of the driving season. For that reason, the government only recognizes as a price increase any jump larger than what the statistical adjustment expects. And if prices fail to go up as much as expected, then the government counts that as a price decline.

Of course, the seasonal adjustment process works both ways. After the peak driving season is over, when gasoline prices usually fall, if they don't decline as much as expected, then the seasonals will show that as a price increase even though motorists may be paying less at the pump that month.

Understanding how the government handled gasoline, however, doesn't fully explain how inflation could appear to be so tame in April, a month when food costs were exploding.

The answer is in the system the BLS uses to weight prices according to an estimate of what the average American spends. Under that method, food only accounts for about 15 percent of the market-basket of products the typical family buys in a given month.

Other sectors which account for bigger parts of the family budget showed only modest price increases or in some cases outright declines. That is what made overall inflation look tame last month.

Housing, the biggest sector — accounting for 42 percent of a family's budget — showed a modest increase of 0.3 percent, down from a 0.4 percent rise in March.

Transportation, which the government says accounts for 18 percent of consumer spending, actually fell by 0.7 percent in April, reflecting the seasonally adjusted decline in gasoline prices, plus price decreases in other areas such as new cars.

Medical care, which accounts for 6 percent of a family's monthly budget, showed a small gain of just 0.2 percent in April. While that price slowdown is expected to be temporary, it helped keep inflation under control in April as did price moderation in other sectors such as recreation, down 0.1 percent, and computers, which have been falling in price for a long time.

The 0.2 percent rise in the CPI for April was part of a trend of moderating inflation this year which is still pretty amazing, given all that is going on right now.

"If you had told me that oil could be going for $125 per barrel, that we would be paying a record amount for a loaf of bread and the dollar would be at its lowest point in 25 years and we would still have inflation as low as we do, I would have said, 'No way,' " said Mark Zandi, chief economist at Moody's

The relentless rise in energy over the past few years has had an impact, certainly in what we pay for gasoline but also in what we pay for food. Food prices rose last year by the largest amount since 1990 and have continued surging this year in large part because of higher energy costs, which means that fertilizer is more expensive. Transporting the produce from the farm to the processor to the grocery shelves costs more, too.

But outside of increases in food prices — partly blamed on an energy-related impact that more cropland has been diverted from growing corn for food to growing corn for ethanol — there has been little sign that higher energy prices have become embedded in higher overall inflation.

The weak economy has played a major role in that by helping to restrain labor costs, which account for two-thirds of the cost of most goods.

With layoffs rising for four straight months and the economy flirting with a recession, there has not been a lot of pressure to raise wages. Indeed, the government reported Wednesday that inflation-adjusted wages for nonsupervisory workers fell by 1 percent in April compared to a year ago, the seventh consecutive decline.

A severe bout of energy-driven inflation in the 1970s did lead to a wage-price spiral as workers began demanding more pay to keep up with soaring prices. That's not expected this time thanks to the inflation-fighting credibility gained by the Federal Reserve.

After aggressively cutting interest rates since September, the Fed signaled with its seventh rate cut last month that it was pausing to make sure it didn't generate inflation pressures that would be hard to contain. Many economists believe the Fed's next move will be to start raising rates, but probably not for another year after unemployment has peaked and started coming back down.

While recessions and near-recessions have a remarkable ability to chase away the inflation dragon, energy remains the big wild card. Forecasters believe crude oil prices, which briefly touched a new record this week close to $127 per barrel, will eventually start coming down.

Rebecca Braeu, an economist at John Hancock Financial in Boston, said she believed oil prices will fall to around $100 per barrel by the end of this year. She believes this will help restrain overall inflation in 2008 to an increase of around 3.5 percent, down from last year's 4.1 percent rise, which had been the highest in 17 years.

"A deceleration in energy prices coupled with lower wage pressures coming from a slowing economy bodes well for lower inflation," she said.