How do we agree on inflation numbers?

Unpacking the most politicized number in economics

Say you want to buy a new phone. 

An iPhone, to be exact. 

But you don’t know how much an iPhone costs. 

So I offer to go and find out for you. 

I find an Apple Store. I go in there, and…

They’re all out of iPhones (this is, of course, hypothetical). 

So I go next door to another store. 

I find the first phone that looks like an iPhone.

I note down the price, come back, and tell you. 

An iPhone costs this much, I say. 

I don’t tell you I couldn’t actually find an iPhone, and that this number is the best I could do in the circumstances. 

And because you don’t know this crucial detail, you now believe an iPhone costs, let’s say, several hundreds of dollars less than it actually does. 

The problem is obvious.

When you go out to buy your new iPhone, you’re in for a nasty surprise;

You will be paying far more than I’ve led you to expect. 

This Benchmark isn’t about phone prices, though. At least, not directly. 

The situation I’ve just described is what’s happening with inflation numbers. 

Perception and reality are important with inflation. 

This is the core problem with inflation statistics: They are treated as objective facts, when in reality they are constructed measures shaped by incentives, methodology, and narrative control.

Systematic wealth erosion: The basics

Inflation is simply the process by which money buys less over time.

That framing sounds intuitive.

Our money buys less over time — we should just accept that’s how our monetary system works. 

Correct or not, inflation is a reality.

Economists measure inflation by tracking changes in the average price of everyday goods and services, usually through a consumer price index (CPI). 

When that index rises, the purchasing power of each unit of currency falls. 

It’s not that the price of goods has spontaneously risen. It’s that the money we use to buy them has been diluted. It’s worth less than it was before. 

Inflation can also result from non-monetary drivers like supply shocks, taxation, regulation, monopolistic pricing and other factors.

When people talk about ‘the inflation rate’, they’re referring to the annual percentage change in the CPI.

This is shorthand for how quickly money is losing (or gaining, if we’re talking deflation) its real-world value.

Day to day, week to week, we don’t really feel inflation. 

Like death by a thousand cuts, it’s a creeping phenomenon.

Inflation’s impact is best observed on longer time frames. 

Here’s a couple of visuals to illustrate the brutal reality. 

What cost $1,000 in 1913 cost $32,808 in 2025. 

It doesn’t get much starker than that. 

Remember, this isn’t because the thing you’re buying is worth 3,180% more.

It’s because the money you’re buying it with is worth that much less. 

Inflation is the systematic erosion of purchasing power, as demonstrated here:

The most politicized number of all?

Governments paint inflation like some external force against which they are fighting.

Their primary policy weapon? Interest rates, set by central banks.

Because interest-rate decisions are justified almost entirely by inflation data, controlling the inflation narrative effectively controls monetary policy.

Interest rates are the most direct lever governments and central banks have over economic behaviour.

By raising rates, policymakers increase the cost of borrowing across the economy.

Mortgages become more expensive. Business investment slows. Consumers defer spending. Asset prices cool. Demand weakens.

Interest rates act quickly. They’re highly visible. They don’t require legislative approval. 

Central banks can deploy them unilaterally, signalling resolve to markets and voters alike.

That’s why rates are the default tool. 

Interest rates are also easy to understand for most people. In countries with high property ownership rates, interest rates have an immediate, tangible impact on mortgage repayments. 

But inflation is almost always the antagonist.

Governments and central banks position interest rates against the big bad wolf of rising prices.

In 2025 especially, we saw highly public statements about inflation and interest rates from the highest-profile politician of all.

Inflation affects elections, wage negotiations, pensions, bond yields and debt servicing costs. 

Governments benefit when they can claim to have driven inflation lower.

So how a government portrays inflation, and shapes the narrative around it, is hugely important. 

Which is why it’s worth getting into the weeds of how they calculate and report on inflation numbers. 

What’s in the basket?

The Consumer Price Index is exactly that; an index. 

Just like the S&P 500 only tells the story of 500 of the biggest companies in the United States, and not the whole economy…

The CPI comes from a basket of items which the government selects and weights in a very particular way. 

They would likely tell you this selection and weighting is representative and makes perfect sense. 

A less-biased observer would likely tell you something different. 

Look at shelter, for example. 

Housing accounts for roughly a third of household spending in the U.S. 

It is, by far, the largest real-world expense for households.

So you’d think the CPI would measure those expenses exactly as people experience them. 

But, CPI is more about measuring consumption than asset prices. 

So rather than count house prices, mortgage repayments, deposits, interest payments and so forth…

The U.S. CPI uses ‘Owner’s Equivalent Rent’ — a survey-based estimate of what homeowners think they could rent their own home for.

An estimate of an estimate, in other words. 

So CPI treats homeownership as if homeowners are renting from themselves.

This is just one example of how the most politicized number of them all gets distorted. 

Between early 2020 and mid-2022, U.S. house prices rose by roughly 40% on a peak-to-peak basis.

For the biggest household expenditure of all, that’s huge. 

Over the same period, the CPI-U shelter component only rose by roughly 15%.

While mortgage payments can double overnight…

Rents adjust much more slowly.

And, for the CPI, you have to wait, too, for the OER survey to catch up. 

Australia saw a similar divergence. 

Real house prices rose approximately 30–35% over the same period, while CPI housing measures increased by only 8–12%, depending on the index used.

That's a 20-25% understatement.

While CPI might be internally consistent, it is misaligned with actual, lived, inflation.

Deflating inflation: Rotation and hedonics

Aside from creatively interpreting and representing major CPI items like housing, there are a couple of other key ways you can cook the books — intentionally or unintentionally — when measuring inflation. 

Firstly, there’s rotation. 

This is where you quietly remove or down-weight items as they become more expensive. 

Example:

Beef prices rose sharply in the early 2000s.

Households couldn’t afford to buy as much. 

They started buying chicken instead. 

So the Bureau of Labor Statistics updated the CPI weights. 

CPI weights shifted away from beef and toward chicken.

While the new item contributes to a lower inflation print…

It doesn’t reflect the reality that the item it replaces became too expensive in the first place. 

The CPI basket therefore tracks utility-equivalent substitutions, not the rising cost of maintaining prior consumption patterns.

This process is known as substitution bias, and while defensible in theory, it systematically dampens reported inflation over time.

Second, there’s hedonic adjustment. 

Let's go back to my phone scenario for a moment. 

The U.S. CPI adjusts smartphones for quality improvement. 

When a new phone comes out with a faster processor, better camera, or more storage, CPI treats part of the price increase as a quality improvement, not inflation.

Your new phone now costs $300 more, let’s say, but CPI records little to no inflation — because the device was judged to deliver more utility.

Rotation and hedonic adjustment give statistical agencies significant discretion over how inflation is recorded.

Over long periods, these methods tend to bias inflation readings downward.

Most of this piece references the most influential economy in the world, the U.S.

Yet, they don’t make the top 10 countries with the most transparent CPI process, as measured by OECD statistical quality frameworks, CPI methodological transparency, and institutional independence of national statistical agencies.

Here’s the current top 10:

🇨🇭 Switzerland
🇩🇰 Denmark
🇸🇪 Sweden
🇳🇴 Norway
🇫🇮 Finland
🇸🇬 Singapore
🇨🇦 Canada
🇦🇺 Australia
🇳🇿 New Zealand
🇳🇱 Netherlands

Institutional incentives and narrative control

Inflation is possibly the most politicized number in economics for good reason. 

Governments have plenty of reasons to want to shape the CPI number.

They also have plenty of ways to do so. 

They design the basket that measures inflation. 

They weight what’s in that basket. 

They decide what to substitute for what — like measuring theoretical rent instead of the actual cost of housing. 

And, of course, they decide when to release data, and how to shape the press releases and media narratives that form around this all-important, ever-changing number. 

Statistical agencies like the BLS or ABS operate within government-defined institutional and political constraints.

They are taxpayer-funded, politically exposed, and incentivised to preserve credibility and stability.

And while central banks are meant to be independent of the governments they serve…

They depend completely on these numbers. Inflation is the number one enemy, remember. 

Monetary policy flows, in large part, from inflation alone. 

Statistical magic

Inflation and CPI are massively important. 

But it’s important to understand that the way these numbers are measured and represented isn’t neutral. 

There’s a lens between the true economic situation, and the narrative the public receives. 

In this way, you can think of inflation numbers as having their own unique inflation — the inflation of fact, accuracy, truth. 

When house prices rise 40% and the government statisticians are saying the number is less than half that…

It’s worth looking closer. 

For households, investors, and policymakers, this gap matters. 

Wages are negotiated against CPI. Pensions are indexed to it. Bonds are priced off it. 

When inflation is systematically understated, real purchasing power erodes faster than the numbers suggest — and trust in the system erodes with it.

This week's quote:

“Inflation is the one form of taxation that can be imposed without legislation.”

— Milton Friedman

Invest in knowledge,

Thom

The Benchmark

Read more: Switzerland just took a stand in the War on Cash.

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