The Fallacy of Deflating Everything by the CPI.

Samuel Williamson, MeasuringWorth & Miami University

What are “Real” Values and what do they tell Us? The Fallacy of Deflating Everything by the CPI. Many economists believe the problem of the measurement of “worth” over time is solved by deflating using a price index. It is not! The question of something’s relative “worth” is more complex than it seems, and we show that an unambiguous answer is impossible absent a specific context. The worth of anything depends on what it is being compared to. In particular, almost all empirical applications that measure “worth” arrive at a “real price” or “real cost” through a single adjustment using the consumer price index (CPI). While it is important to remove the inflationary component when making intertemporal comparisons, we maintain that the “real price” often does not provide the comparison one wants, does not answer the question one is asking. Our empirical computations exhibit how different definitions of worth, different “deflators,’ can give answers that differ by up to 2,000 times when comparing between 1790 and today. The indexes we use include average household expenditures (AHE), indexes of earnings such as long-run wage series, GDP per capita, and the share of GDP in addition to the CPI. For example, $100 from 1940 “inflates” to $2,004 today using the CPI. That same $100 would inflate to $3,772 using the AHE, $6,157 using the compensation of production workers, $9,267 using GDP per capita, and $23,331 using GDP. The purpose of this paper is to develop a process to be used when relative “worth” is computed and to provide guidance for selecting the best index, or a combination of indexes, to measure the changes in the worth of something over time.

No extended abstract or paper available

 Presented in Session 35. Measuring the Fisc