By Jason Williams, Financial Analyst, Mark H. Smith, Inc.

Economic Update: The Billion Prices Project and Inflation

Traditionally, inflation is measured by the Consumer Price Index (CPI) which creates a baseline for a basket of goods purchased by a typical household and then measures the increase (or decrease) in the prices of that basket of goods over time.

Weaknesses of the CPI are, of course, the fact that a basket of goods cannot possibly represent all of the goods and services that a consumer will buy and the fact that the basket of goods will change over a 5, 10, or 20 year period. Think cell phone service, once considered a luxury good, now considered a basic utility. There are many examples of these kinds of changes to goods and services included in the basket.

One of my favorite alternative economic studies over the last few years has been the Billion Prices Project started by a group of economists at MITi. The Billion Prices Project uses computer software programs written to “scrape” the internet for the prices of all the goods and services that are offered there. By scraping the internet daily, a new inflation measurement tool was created, referred to as the PriceStats Indexii. We watched this index closely, especially during the years 2012-2013, when PriceStats was telling us that inflation was actually running 2.5-3.0% but CPI was telling us that inflation was running 1.5-2.0%. Ask yourself the question: “Does it feel like I spend more for the goods that I buy, the cars that I drive, and the utilities that I pay now than I did five years ago?” The answer to your question is probably yes. PriceStats may be a help in measuring this.

Although there is no measure of inflation that is perfect (PriceStats has weaknesses too), PriceStats picked up the plunge in inflation when gas prices fell well before it was picked up by the CPI index. Recent PriceStats index data indicates that inflation is firming up, and then going up this summer –faster than economists realize.iii

How might the recent data on inflation affect our credit union clients? There are lots of ways, but here are just a few examples:

  • One of the main translations of inflation to our credit union clients is the effect on home prices. The Case-Shiller 20 City home price index is up 5.03% in one year and 9.01% in three years!iv We have mentioned in previous economic commentaries the growth in real estate loans for many of our clients. Some inflation is a good thing in this area. It keeps loan to value ratios healthy.
  • Another is in mortgage, auto, and other loan rates. Some inflation here is a good thing as well. The net interest margin for so many of our credit union clients has been compressed over the last 3-6 years. Inflation should drive these rates higher over the long term. As long as the rise is gradual, your net interest margin should improve. For providers of financial services and products pricing power is welcome.
  • High inflation (although economic indicators would tell us this is not a great possibility) is the enemy of any fixed rate asset that the credit union holds. Fixed rate investments and fixed rate loans erode their value in that kind of environment.
  • With inflation, wages and the cost of labor to the credit union increase.

Next time you shop for something on the internet it is possible that the price of the good or service you purchase has already been recorded by the Billion Prices economists at PriceStats. Utilizing this tool and others that are being created using “big data”, we don’t have to rely just on CPI anymore.

As always, if there are specific questions that you have regarding the interest rate risk at your credit union please don’t hesitate to contact us.

i – The Billion Prices Project @ MIT:
ii – Wall Street Journal, March 13, 2015:
iii – PriceStats:
iv – S&P Dow Jones Indices, 20 City Index Returns: