Mark Thornton of the Mises Institute wrote an article on the many failures of the CPI.  His article is worth a read, but I am going to add a few things that were not directly mentioned.

First off, I will often do a short commentary on the latest CPI numbers for my readers.  I fully acknowledge that the CPI statistics are government-issued numbers and are far from reliable in actually telling us the true inflation picture.

I use the CPI though for a couple of reasons.  First, the Fed and financial analysts look at this data, so it is important just from that standpoint.  For example, if the CPI comes in low, then the Fed is more likely to pursue a looser monetary policy.

A second reason I use the CPI is for trends.  It doesn’t give us a good picture of asset bubbles, such as in stocks or bonds, but it can help us with trends for daily consumer goods.  While the CPI has its many flaws, it can still give us a decent picture of what prices look like.  I can also look at my grocery bill, but it is too small of a sample with too many variables.

Near the end of his piece, Thornton quotes someone writing about what prices would look like today if the money supply had not changed since 1959.  For example, a hamburger would only cost 12 cents today.  But this short excerpt is open to criticism because he does not address the fact that nominal wages are also far higher today.

The bigger point that needs to be made is that central bank monetary inflation distorts markets and misallocates resources.  This will tend to cause bubbles.  It will also cause certain prices to rise before others, and wages typically lag behind.  It also harms savings and production.

I think many libertarians and Austrian School economists make a mistake sometimes in obsessing over price inflation.  I hear many say that price inflation is severely understated right now.  That may or may not be the case, but that is not the main point.

Rising price inflation is not the only bad consequence of the Fed’s monetary inflation.  It is not even the biggest consequence in most cases.

As stated above, the Fed’s monetary policy misallocates resources.  This is the main problem.  It doesn’t matter if the CPI is at 1% or 10%. If the Fed is creating money out of thin air, then it is misallocating resources and distorting savings.  It redistributes wealth and it makes our overall standard of living lower than it otherwise would have been.

When the Fed started increasing the money supply like crazy in the fall of 2008, many libertarians were predicting runaway price inflation.  Some were even saying we would get hyperinflation.  Some are still saying that.

But Austrian economics isn’t supposed to predict that for us.  What Austrian economics does is tell us this monetary inflation is bad for the economy.  It tells us that resources are not being put to their proper uses and we are poorer for it.  A rising CPI is just one possible consequence of an increasing money supply.

Price inflation has stayed relatively low because most of the new money created by the Fed went into bank reserves.  We have not seen the fractional reserve lending process multiply the money.  In addition, money demand has stayed high because some fear remains from the last major recession.

We may still see high price inflation in the future.  That is what I am betting on.  But it doesn’t make Austrian school economics wrong if we don’t get high price inflation, regardless of how you measure it.  Austrian economics tells us that we would be better off if the Fed doesn’t engage in massive monetary inflation.  It can’t predict the future though, and it can’t give us the exact consequences of such a policy.

In conclusion, the CPI is useful in giving us trends.  It is also useful in helping us guess Fed policy going forward.  The CPI is useless – at least these days – in telling us the damage that the Fed has done.  The next major recession will give us a better indication of just how much damage the Fed has done.