In 1986, The Economist magazine created the “Big Mac” index. The theory is that this is a standardized product, available around the world, which likely would continue to be sold for many years.
In the US in September 1986, the Big Mac sold for $1.60; it was selling for $4.62 in January 2014, 27+ years later (328 months later).
That works out to just under 4% per year price inflation. Using the CPI to figure out what the Big Mac should cost today gives us $3.40, or well under the actual $4.62 price today.
It would appear that the CPI understates the actual increase in prices over the last 27+ years.
But, what difference does it make? It makes a big difference!
- A lower than real number reported for CPI means that the voters think that Inflation – how much purchasing power value our salaries and life savings have lost to bad government policy – is worse than we thought.
- As prices and earnings ratchet up, our Tax Brackets creep up as well. We don’t pay proportionately more, we are taxed at a higher rate.
- If we get a return on our life savings which just matches Inflation, then even though we have had zero real return after Inflation, we have to pay tax on the make believe gain.
- Nominal GDP is adjusted for Inflation to get Real GDP. If the Inflation number is artificially low, the Real GDP is artificially high, and voters are misinformed about poor government policy.
- If your earnings are tied to Inflation (eg. Social Security, some wage contracts, Inflation Protected Treasuries), then you’re getting less of an adjustment than you should. An artificially low-ball CPI number is cheating you.
Action Item: The CPI and other government measures of Inflation should be audited by an independent body, which should fix the calculation methodology. Once it’s fixed, it should never be allowed to be changed. Previous adjustments should be investigated, and if it’s determined that they were politically motivated, guilty parties should go to jail.