Practical Dad

Calculating Real Price Rises:  The Effect of “Stealth” Inflation

What is the true effect of "stealth" inflation and to what extent does it hide the real effect of price increases to the consumer?

People who do the family shopping can tell when things have obviously gone up in price, a pound of hamburger being a classic example.  But there are instances when the shopper will look at something and suddenly wonder if the package - the container itself and not the design - is different.  The sense is occasionally akin to seeing something out of the corner of your eye and wondering whether that actually occurred or if you imagined it.  What is now referred to as "stealth" inflation is when a manufacturer alters the package size in order to minimize the price increases that are being  passed on to the consumer; if you know that too large a rise in price will cause the consumer to shift elsewhere, you simply pass through a smaller increase and quietly cut the package size so that less is being sold per package.  The net effect is a nominal price decrease - or no change - on the package but a slight increase in the package's profit per unit (ounce, for example).

The real impact of stealth inflation is that the true price that people pay is understated by an unknown amount.  The sticker for the item sold might say $1, but in reality, the consumer has to pay $1.10 for the same amount than was purchased before. 

With questions about how the monetary policies of the Federal Reserve - Quantitative Easing and ZIRP - affect the economy and whether they would ultimately fuel inflation, I created the PracticalDad Price Index in the Fall of 2010.  The index consists of 47 separate items commonly available in the grocery store and each is for the less expensive store brand, unless there was no generic equivalent available at any of the three unrelated supermarkets.  The philosophic premise behind the basket is that it's composed of common grocery items that would be purchased by a cost-conscious parent, trying to make ends meet on a simple monthly budget; it doesn't presume to be the full quantity of food that would be purchased by a family of X members for a month but only the type of common item that a family would purchase. 

The key to running a price index is consistency.  Not only must you track the specific kind of item, but you also have to keep tabs on the packaging size as well.  Comparing one size can in a store to another size in a different store is an apples to oranges comparison and thus useless; in the case of the index's ice cream entry, one store's generic container was different from the others and I was forced to price on a unit (per quart) level.  The problem with pricing on a unit level is that it becomes impossible to account for stealth inflation and that was one of the factors that I wanted to track.  Over the two years, when I've noted instances of stealth inflation via packaging, I've adjusted the item's price to what it would be for the original container size.  For example, all the grocery stores in November sold store brand coffee in 13 ounce containers.  When a store began to sell in 11 ounce containers, I converted the new price for the 11 ounce container back to an equivalent amount for the original 13 ounce container. 

Example:  Store A sold coffee at $3.50 in a 13 ounce container.  The next month, it sells coffee for $3.40 - a nominal price decrease - but the container is now 11 ounces.  Recalculating for the change [($3.40/11)*13] yields an equivalent price of $4.02 for a 13 ounce can, were the coffee sold in the old container size of 13 ounces.  Et Voila!  A nominal decline of 2.8% hides a real increase of 14.8%.

The first pricing occurred in November, 2010 with the full cost of the initial basket at $178.39, which became the index basis level of 100.  It wasn't until the Spring of 2012 that I considered the effects of policies upon food alone and apart from non-food items; of the 47 items in the basket, ten are not food items per se, but grocery items such as soap, aluminum foil and ibuprofen.  I subsequently returned to the data and separated the ten non-food items from the remainder with the result that of the $178.39 spent on the entire basket, $89.14 was spent on food only.  This amount of $89.14 for November 2010 became the index basis level of 100 for food only.  Of the 47 items in the marketbasket, five items have undergone package decreases in the past two years, either in all of the stores (coffee, sugar and women's pads) or in at least one of the stores (orange juice and kidney beans).  Each of the items is recalculated to account for the stealth inflation.

The results of the October 2012 - the 24th month of data collected - are presented below for both the Total Index and Food-only Index (November 2010 = 100).  The first column - "Actual" - is calculated for the Index and accounts for the impact of stealth inflation.  The second column - "Nominal" - lists the Index figures using the nominal prices on the grocery store shelves, without adjusting for the impact of stealth inflation. 

                           Actual          Nominal                   

Total Index         106.42         105.02           

Food-only           111.80         110.17           

In the Total Index, the nominal figure of 5.02 is a startling 28% [(6.42-5.02)/5.02] understatement while the Food-only Index is 16% understated [(11.8-10.17)/10.17].  In fairness, the massive Total-Index understatement can be statistically attributed to the oversized effect of the price activity of one item - specifically women's pads - in relation to the total dollar value of the basket.  The pads have undergone large price declines in both nominal and real terms over the two year period and this has produced an outsized effect upon the basket.  But when this item is removed along with the remainder of the non-food products to leave only foodstuffs however, there is still a significant 16% differential between the nominal and the stealth-adjusted figures.

The upshot is this.  A great deal, both in terms of Fed policy and actual government spending, is predicated upon the possession and use of accurate information.  If the information is badly misrepresented or skewed, then the policy actions will be correspondingly skewed.  The Fed and the government presently state that inflation, the core-CPI, is minimal and are pursuing policies intended to provoke an upshot of inflation.  But is the price information that they're using accurate or are things percolating along even more than is reported?

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