Everyone from Main Street to Wall Street watches the inflation numbers. If the numbers are going up, we assume the Federal Reserve will take action. With so much riding on the veracity of the numbers, it was vital that a full review of their accuracy be instituted.
Accordingly, a Congressional Advisory Commission on the consumer price index (CPI), chaired by Michael Boskin, was formed. After study, the commission reported that the CPI overstated the change in the cost of living by about 1.1 percentage points per year. This number seems small, but compounded over time, the effects are enormous. For example, instead of falling 13 percent, real hourly wages actually rose by 13 percent from 1973 to 1995.
With about one-third of federal budget overlays indexed to the cost of living, as are income-tax brackets, the distortion between the numbers reported and the real world is huge.
Many analysts also look at a nation’s savings rate to predict how its economy will unfold. For Example, a low savings rate may foretell a scarcity of capital that could cramp the growth of the economy, whereas a larger rate portends ample money capital for expansion.
Many commentators have deplored the fact that Americans don’t save enough money and that our savings rate is said to be low compared with that of other nations. And although the official numbers seem to confirm this story, it is the way these numbers are put together that assures this result.
Press reports on these numbers often run in juxtaposition to stories reporting that the inflow of money to mutual funds has just hit an all-time high, that the purchase of new homes (many people’s principal asset) continues apace, that IRAs and 401Ks are bulging with cash, and that many corporate pension funds are overfunded. All of these events, plus the purchase of consumer durables, represent savings by Americans and constitute a direct disconnect from the official savings number that is derived by computing savings as the proportion of disposable income individuals set aside.
Measurement in the private sector is hardly any better. The industrial age that spawned our accounting rules had hard assets-things that you can touch and count, such as buildings, factories, and inventory. In the new economy, intellectual capital is far more important that money capital, but so far it goes mostly uncounted in the balance sheets of our corporations because it is largely ignored by the writers of accounting standards. Examples abound, but to cite just one, the value of patents is nowhere to be seen on our corporate balance sheets. This is not a trivial number.
The American accounting profession has now produced 5,000 pages of accounting rules, but Robert Elliott, a partner of KPMG, pointed out, “At best, today’s financial statements are an obsolete product. Relatively unchanged over the last 100 years, financial statements were designed to describe industrial-era assets: inventory, machinery, buildings, and land. Post-industrial enterprises run on intangible assets, capacity for innovation, and human resources… Yet non of these appear on the balance sheet.”
