Reply #4: Cost of living vs. inflation [View All]

Cost of living is a bit different from how inflation is calculated, and the word inflation can mean a couple of things.

When we talk about inflation, normally we think of things in terms of price, since that is what has the real effect on us. But when economists talk about inflation, usually they mean monetary inflation, changes in the money supply.

The money supply is being destroyed at an amazing rate. The reason is that debt is part of the money supply, and loans made in the past are defaulting at unprecedented rates. Until this phenomenon is played out, monetary deflation is a given.

However, that may not translate in lower prices to you and me, since what they are doing to mitigate the damage is effectively printing money to fill the debt hole, and this in turn lowers the value of the currency. Lower currency value means more expensive oil, the price of which is reflected to some degree (primarily with respect to transport costs) in virtually everything you buy.

What is reasonable to expect given current policies is more of the same, prices for necessities stay even or rise (while prices for many luxuries drop due to dropping demand). If you're living tight and/or are on a fixed income, this will suck. More so if you have to commute by auto in the face of sharply rising gas prices.

The kicker is that when they calculate a cost-of-living adjustment, they do it using a formula that heavily weights things that depend on money supply, e.g. the price of houses. They're also using a witches' brew of heuristics to essentially pull the numbers out of their collective asses that generally translates to the lowest number they think they can get away with on a political basis. Look up terms like "owner equivalent rent" and "CPI calculation" for gory details on that particular sausage-making process. Nobody will blame you if you don't like what you see!