Sources: Bureau of Labor Statistics, S&P Case Shiller
So, our first adjustment to CPI is an effort to adjust for the actual cost of owning a home rather than the cost of renting. We wanted to capture the fact that most Americans own their homes. While the home ownership rate has declined over the past few years, some 64 percent of households still own their homes. We think that the cost of buying those homes should be represented. So, our adjusted CPI uses a weighted average of the CPI's "Rent of Primary Residence" and the Case Shiller U.S. Housing Price Index for the cost of shelter. The weights for each component of "shelter" inflation were determined by the home ownership rate in each year.
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The CPI also does not account for the cost of saving for retirement. From my vantage point, saving for retirement is one of the consumer's biggest expenses. Think about it; how much do you put away each month for retirement? Now think about how prepared you are for retirement given your age. If you are like the large majority of Americans, you remain woefully unprepared despite huge increases in stock and bond prices over the past few years. Next, think about the returns that you will likely earn in your retirement accounts in the future. Do the huge increases in stock and bond prices over the past few years increase or decrease your expected returns in the future?
We think these are very important questions as they relate to the health of the U.S. consumer. Various inflation metrics need to account for the fact that: 1) at any given age bracket, the large majority of consumers remain well underprepared for retirement; 2) today's high prices for stocks and low yields on bonds will likely lead to below-average returns on these assets in the future; and 3) lower expected returns in the future will mean that underprepared savers will need to set aside more for retirement, effectively raising the cost of saving for retirement. In order to account for those rising costs, we make an adjustment for stock and bond prices.
To include financial assets in our adjusted CPI, we simply included annual changes in the S&P 500 index and the Barclay's Capital U.S. Bond Composite index. The S&P 500 and Barclay's bond indices received arbitrary weightings of 10 percent and 5 percent, respectively, in each year. Making this adjustment ensures that the cost of saving for retirement is accounted for as asset prices fluctuate. Again, as asset prices increase (decrease), the cost of saving for retirement increases (decreases) due to: 1) the fact that the overwhelming amount of Americans remain underinvested; and 2) large increases (decreases) in stock and bond prices will translate to lower (higher) expected returns in the future and the need to set aside more (less) money to reach retirement goals.
In the table below, we show what the weightings would look like for our Adjusted CPI in 2014.