How reliable are those inflation reports?

Q: I live in Los Angeles.  They say that the CPI for the area is around 3 percent.  Just go buy groceries, insurance, or eat at a restaurant, actual prices in many enterprises locally have increased 10-20 percent.  How can we believe that prices are really going up only 3 percent when the store prices for just about everything has risen over 10 percent? —Phil M., Los Angeles

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A: It’s a little like the economist who has one hand on the stove and the other in a bucket of ice. He’ll tell you that, on average, he feels pretty good.

And that’s all the CPI statistics show: an average. The Bureau of Labor Statistics collects monthly data from 87 urban areas throughout the country, including about 23,000 stores and businesses (for prices of goods and services) and some 50,000 landlords or tenants (to calculate rents).

Aside from big regional differences, price change vary widely from one category of products and services to another. Since Jan. 1998 (through May of this year), for example, food prices overall were up 16.5 percent. But medical care services were up 29.9 percent. Apparel prices, on the other hand, fell by 4.5 percent during that period. And within each category, prices changes vary as well: beef and egg prices have risen sharply in the past few years, but coffee prices have actually fallen (not counting Starbucks).

You’re also correct in your assumption that prices in Los Angeles are rising faster than the national average. Since Jan. 1998 (through May 2004), prices in LA have risen 20.4 percent, while the national average is up only 16.6 percent. It turns out our national economy is very regional -– especially when it comes to the cost of living. Just ask anyone from who’s moved recently from the Midwest to the east or west coasts and gone house hunting.

Then there’s the matter of how much weight to give each item in calculating the average CPI, which the BLS calculates based on overall (there’s that average again) spending levels. But few people, if any, spend exactly these “average” amounts in each category. So if you spend more of your money on clothes than I do and don’t have college tuition bills to pay, you’re personal inflation rate will be a lot lower than mine. (Here’s how the BLS weights each item.)

So why bother crunching all these numbers and coming up with an artificial average that has little connection to real life spending by individuals? Because these averages are useful in making judgments about changes in the overall U.S. economy – especially in monitoring changes over time.

But they aren’t meant to track how your personal spending has risen or fallen. The BLS collects millions of bits of data each year, but even their computers can’t keep up with the individual spending habits of nearly 300 million Americans. Nor, it’s safe to say, would we want them to.