Why does the Consumer Price Index seem "fake" to us?

Many times I have read or heard from many people that the Consumer Price Index (CPI) is "falsified" at best or subject to deliberate manipulation at worst, and in any case does not faithfully reflect the actual changes in product prices. In this article, I will try to address this claim.

What is the Consumer Price Index?

In a healthy economy, product prices rise moderately over time. In an unhealthy economy, prices do not rise at all, they fall (deflation), or they rise sharply (hyperinflation). The explanation for why prices rise moderately in a healthy economy will perhaps be in another article. This rise in prices is called Inflation Coming from the Latin word "Inflatio" - inflation. In practice, this word is used today only for price changes of products, but not a single product but a basket of products. The consumer price index is our way of measuring inflation. Just as a gram is our way of measuring weight and Celsius is our way of measuring temperature.

How is the Consumer Price Index determined?

Once every few years, the Central Bureau of Statistics conducts a survey among several thousand families, and at its end, it publishes the Average shopping cart from an Israeli family. This basket includes Hundreds of products You can also find it on the Bureau's website. Not only does the Central Bureau of Statistics publish the list of products the average family buys, but also the percentage of family expenditure on each product in this basket. The basket of products that the Central Bureau of Statistics (CBS) examines includes about 1,300 products. If you think 1,300 products is a lot more than you buy in a month, it's worth remembering that you are not an average family but rather the Cohen, Sapir, Nachmias, Halevi, Chait, etc. family. It's possible that this month you didn't buy a car, sofa, television, or bicycle. But, On average You purchase a small portion of these products every month—whether you’ve bought them before or not. Since enough families do buy them, these products are included in the basket. For example, transportation and communication products account for 2.21% of the index. By the way, regarding transportation, you don’t even notice that you’re buying some of the products included in this category. You pay 15,000 for a car service, and that service includes motor oil. Even if your car is electric, On average You buy motor oil. Apartment maintenance, 9.5% of the index. Food excluding vegetables and fruit, 13.5% of the index. And here, too, vegans are suffering from rising meat and dairy prices because On average He "consumes" them. In this context, it's interesting to see the changes that have occurred over the years. For example, transportation in the past consumed a tiny portion of the family consumption basket because most people didn't have cars. Today, the average family has more than one car. Food, on the other hand, has significantly decreased in terms of its consumption as part of the family budget. This is not because food has become cheaper, but because, unlike, for example, trips abroad where the more money you have, the more you travel, food has a biological limit to consumption. And since the overall basket has greatly expanded, the average Israeli family today is much wealthier than families in previous generations, the portion of food has decreased. Unfortunately, I haven't found up-to-date data, but the trend up to 2014 is fascinating to me:

Once the bureau has the basket of products that the average family buys in a month, the bureau virtually goes each month and tries to purchase this basket, meaning it approaches those who sell the products constituting the basket and checks at what price they sell the basket's products. If the price has increased Compared to last month They say the index rose and they publish by what percentage it rose. If the prices of the basket of goods decreased Compared to last month, They say the index went down, and here they also publish by what percentage the index went down compared to the previous month.

Why is the index interesting to us?

Information regarding changes in product prices is of great importance to both decision-makers involved in managing the country's economy and to the average citizen (whose concerns are neither small nor simple). On the state's side, I previously mentioned that a steep price increase is a destructive process for the economy that also causes great suffering to citizens, and therefore efforts should be made to prevent it. The government and the Bank of Israel, who are responsible for the economy's health, have the ability to take steps to moderate price increases. To know if prices are rising And how much, yes Measure the price increases. For someone who took out a loan or signed a contract with an index-linked component, it is certainly important for them to know whether the index rose or fell.

On a private level The metric is used often when one wants to talk about the real value of a product – its actual value. Think about a situation where you pay, say, 10,000 shekels for a refrigerator, but the refrigerator never arrives. You file a lawsuit against the seller, and after two years, you receive a judgment in your favor. You no longer need the refrigerator because you bought another one, and receiving 10,000 shekels does not accurately reflect Your actual damage. Let's say that over these two years, the index was 5% each year. The payment you are supposed to receive is not for a refrigerator, since you don't need one, but it is supposed to be Equivalent to a refrigerator. The judge can look online to see how much a similar refrigerator costs at today's prices, but it's not certain that such refrigerators are still sold, and the judge's time is limited. What is generally done is to attach the original price to an index that reflects inflation. Average In terms of product prices. What you’ll actually receive is 10,000 * 5% (an increase of 5% for the first year) = 500, plus 10,500 * 5% (an increase for the second year) = 525, for a total value of 11,025 shekels. It’s possible that in reality, refrigerator prices rose more, rose less, or even fell, but this is the standard way to adjust monetary value over time. It works the other way around, too. Let’s say I want to sign a contract with a wedding hall owner for a wedding that will take place in a year. We can agree on a price of 250 shekels per serving. But what if, over the course of the year, the prices of raw materials for preparing the meal rise, and by the time of the wedding, it’s no longer profitable for the venue owner to feed my guests? To prevent such a situation, we can stipulate that the price we agreed upon is indexed to the price index. After a decade of an index trending toward zero, we’ve hardly needed to make such calculations, but the tool to do so still exists. One final example from the real estate world. When selling an apartment, one sometimes pays Capital gains tax: A tax of 25% on the difference between the purchase price of the apartment and its sale price. Let’s say I bought an apartment 20 years ago in Kiryat Ono for 400,000 NIS, and that apartment is worth 2,000,000 NIS today. So when I sell it, I’ll pay a 25% tax on 1,600,000 NIS. In practice, that’s not how it works. Remember the rule that 400,000 shekels 20 years ago is not equal to 400,000 shekels in terms of Purchasing power Today. Therefore, first thing What is this?(from the Hebrew word "hon" or "hoveh") to their present value. This can be done with Index-linked calculator here. The 400,000 from 20 years ago will be worth 569,000 shekels in November 2024, so the total tax is "only" 25% out of 2 million minus 569,000 = 357,000 instead of the 400,000 I would have paid if I hadn’t indexed the original price to the CPI. Saving over 40,000 on a small calculation.

Anyone buying an apartment from a contractor is certainly familiar with Construction input price index. The principle is similar, but instead of looking at the prices of tomatoes and refrigerators, we look at the prices of iron and cement.

So why does it seem to us that the index doesn't reflect the actual price increases? The feeling that the index does not faithfully reflect actual price increases is shared by many citizens. Around the world. There are several reasons for this, and it's important to be aware of them. Navigating the economic world with misconceptions such as Conspiracy Whether it's the government against citizens or various companies against citizens, as I've heard from many over the years, it's a perception that harms all our decision-making. When we think there are all sorts of unknown and malicious forces plotting to harm us, we reduce our own responsibility and arrive at poorer outcomes. There are several reasons people think the index doesn't reflect reality:

Focus on recent purchases

Let’s say I remember that a serving of falafel used to cost 10 shekels; a while later, I see that it costs 15 shekels, and today it costs 22 shekels. I tell myself, inflation is crazy. Over 100% inflation over, say, ten years is about 10% per year (not exactly, but that’s a misconception anyway). What I forget when I think about 100% inflation over a decade is the weight of the falafel portion in my basket of goods. If, for example, the share of falafel in the basket is 0.0001% (assuming a falafel portion is even part of the basket at all), then a 100% increase is not significant at all. Moreover, when I see a phenomenon like this, I usually forget that the falafel stand near my house doesn’t represent all falafel stands. It’s entirely possible that elsewhere, falafel is still sold for 15 shekels instead of 22 shekels. I see before me Anecdote and not average.

Furthermore, if a falafel meal used to cost 10 shekels and now costs 20 shekels, then there was a 100% increase in the price of a falafel meal from 2010 to 2024, for example. But if we’re approaching 2025 or maybe even 2026 and the price of falafel is still 20 shekels, then the index increase is zero over all those months, even though in our minds we remember the falafel that cost ten shekels back then. Every time When we buy it at double the price, we have a constant reminder that the price has gone up and it seems to us that inflation keeps running.

A basket of goods that seems unrepresentative

Suppose I see with my own eyes, vegetables, fruits, fuel, and electricity becoming considerably more expensive. It seems to me that the index should rise, representing this price increase. What I didn't notice, because I didn't buy it this month, is that a living room system with a five-seat sectional sofa was significantly reduced in price. At the same time, a collection of products including a compass, flashlight, digital navigator, portable music player, and portable video game console was significantly reduced in price. I have no idea if these products were actually reduced in price, but surely you must have asked yourselves who buys such a strange collection of products when all these things are inside a mobile phone. That is precisely the point. Technological advancement Allows compressing 5 products into one, making the total cost of all products much cheaper. Thus, if in the past, for example, there was a purchase component of three CDs per year for a family, this was converted into a much cheaper Spotify subscription. This change goes over our heads because when we think about the index, we think, for example, about The product CD and not on Service Playing music at home that can be done with Spotify. To the point Service versus product I'll be back. In the same way, many people give up on buying an expensive home stereo system with imposing speakers, and instead settle for one network speaker or another that connects to their phone. In these cases, we haven't really experienced a price drop for the product, but rather, from our perspective, we've replaced technologies. From the Bureau of Labor Statistics" perspective, this is definitely a reduction in the cost of music playback service in our homes. My parents' first color television was 22 inches. As strange as it may sound, my computer screen is larger, and 60-inch TVs and even larger are very common. When we pay the same amount but get more, this is also calculated as a price reduction.

The Central Bureau of Statistics updates the basket of goods every two years according to changes in the market and consumer preferences, but in a world of such rapid changes, this may certainly not be enough.

Sometimes the lag in representation acts in an unusual way. See, for example, the different product families for the August 2024 index and their impact on the overall index:

It is clear that prices for telephone services, television, clothing, and automotive fuel and lubricants fell by a fairly significant margin; however, because their share of the consumer basket is low, the overall impact was minimal. In contrast, international airfare rose by a staggering 221%. Most of us didn’t feel this because there were no flights and few people were flying. This is also the reason for the price surge. On a flight abroad. This affected the index and, through it, mortgages and other index-linked products, even though very few people were impacted by the rise in flight prices because it was simply impossible to travel. We all felt the rise in tomato prices in our wallets, but the 37% increase in price (within a month) translated into a much smaller increase in the index itself due to the relatively small share of tomatoes in the family consumption basket.

Why aren't apartment prices part of the Consumer Price Index?

One of the strangest things for people is the fact that housing prices are not part of the consumer price index. The consumer price index represents Consumer goods and services We are rinsing. I described above how, from the perspective of record prices, we moved to the perspective of music services. The result is the same result – our desire for music at home, but the means have changed. The housing section can still be consumed in two forms: Owned apartment Who lives there or Employee housing services – rental housing. The CBS in Israel and worldwide examine housing services – rental prices, and they constitute a quarter of the consumer price index, meaning a quarter of monthly household expenses. The accepted notion is that purchasing an apartment For residence or investment In any case, it is an investment rather than a current expense. Some argue that a residential apartment is a consumption item, whereas an apartment that the owner rents out is an investment. I propose a different method for distinguishing between an investment and a consumption item. When we buy a property as an investment, regardless of how it is used, our (realistic) expectation is that its value will increase over time or that it will generate a regular income for us. When purchasing a property for consumption, our expectation is that its value will decrease, and it will usually provide us with other benefits, such as enjoyment. When we purchase an apartment, it is a very reasonable expectation that its value will increase over the years, and therefore it is an investment. Just as stock prices are not included in the index and Bitcoin prices are not included in the index, neither are apartment prices. In general, there is a correlation between apartment prices and rental prices. The standard annual rent is approximately 2.51–3.1 times the apartment’s value, and as the apartment’s value rises, rents will also increase over time. Thus, the distinction regarding how to treat housing prices within the index is not particularly significant.