NOTE: The following article appeared in our quarterly inflation outlook, distributed one week ago to clients. We thought it might be interesting to a more general audience.

...The deceleration in medical care inflation is not the queerest change in price inflation we have seen in the last quarter. The prize there clearly goes to inflation in wireless telephone services. In the March CPI (released in April), core inflation overall declined -0.12% - the biggest monthly drop since 1982. But a large part of the blame for that curious result, which was more than a quarter percent below expectations, fell on the single category of wireless telephone services.

The chart above shows the year/year change in wireless telephone services inflation. The current y/y rate is nearly -13%, but that isn't the striking part. Wireless telephony is generally in a state of deflation. But the one-month change of 7%, in a category that constitutes 2.2% or so of consumption in core categories, trimmed one-sixth of a percentage point from the core number. The 7% single-month decline is completely unprecedented and happened because of the way that the BLS samples wireless telephone plans and how it accounts for the value of changes in the components of these plans. In short, the BLS method severely exaggerated a small effect.

How the BLS Methodology for Wireless Plans Exaggerated a Small Effect

In sampling wireless telephone plans the BLS does not take into account the fact that, unlike with many products, telephone plans are consumed continuously but at a pre-set price that is different for each consumer based on the plan that consumer previously bought. If you go to the store and buy Pop-Tarts, the price you pay is the same as the price that everyone else pays. So, the BLS can easily figure out how much of the average person's consumption consists of Pop-Tarts, and track the price of Pop-Tarts, and arrive at a good estimate of how the cost of the average person's consumption basket changed as a result of changes in the price of Pop-Tarts. Moreover, if the size of the box of Pop-Tarts changes, or if Pop-Tarts are replaced by Pop-Tasties (which, let us suppose, are like Pop-Tarts but are sold by a different company and are slightly different), the BLS analyst can make an intelligent substitution based either on comparing the price of Tarts and Tosties when they overlapped, or by comparing the characteristics of Tarts and Tosties and adjusting the price series for Toaster Pastries to reflect the new items on sale.

Contrariwise, with wireless telephony only people taking out new contracts are paying the new prices. However, the BLS doesn't have a way to survey consumers generally to find out what the average consumer is currently paying and what the average plan looks like. Instead, they survey various sales outlets (most of this is done online) and see what plans are being offered to consumers. They adjust the price of the wireless telephony series based on changes in these plans over time...but notice that this will tend to exaggerate moves, since it effectively implies that everyone rolls over their wireless contracts every month into a new plan.

Ordinarily, this is not a crucial problem; in March, however, a number of carriers introduced unlimited data plans. Although the BLS doesn't specifically evaluate the price per gigabyte of data, they effectively do something similar when they compare the old plan offered (which had some amount of data at a fixed price) to the new plan offered (which has unlimited data). "Infinity gigabytes" is clearly a lot better than "four gigabytes," but it is difficult to say how much better when most people will not immediately consume dramatically more data when moving to the new plan.

So in March, the BLS series for wireless telephony had two problems. First, the introduction of a number of new wireless data plans caused the quality of the sampled plans to look much better for a similar price. Second, and more importantly: even though the price wars in telecom didn't affect very many people – only those who were changing their plans that month – the BLS methodology acted as if the average consumer moved to the new plan, and that greatly exaggerated the effect. In short, the BLS series for wireless telephone services vastly overstated the deflation experienced this quarter – but the tradeoff is that it will understate the inflation experienced in the future, as users gradually migrate to unlimited data plans.

P.S. Don't forget to buy my book! What's Wrong with Money: The Biggest Bubble of All. Thanks!

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Enduring Investments is a registered investment adviser that specializes in solving inflation-related problems. Fill out the contact form at http://www.EnduringInvestments.com/contact and we will send you our latest Quarterly Inflation Outlook. And if you make sure to put your physical mailing address in the "comment" section of the contact form, we will also send you a copy of Michael Ashton's book "Maestro, My Ass!"