Inflation as an Arbitrary Concept
In Should We Adjust Prices For Inflation? I discuss my concerns with the concept of inflation. The short story is, because our 'representative basket of goods' changes over time due to technological and social changes, there is simply no objective way to measure changes in the 'price level' (that is, there is no such thing as a 'changing price level' in an objective sense. I was delighted to see that Scott Sumner agrees with me:
Inflation is an arbitrary concept that has never been clearly defined, or at least defined in a way that relates to how it is actually measured.
He then links to an earlier blog post - Six reasons to abolish inflation, which ends with:
What's the use of inflation? It's worthless. Let's get rid of it. Take it out of our models. Take it out of our policy rules. If indexing is required then use wage inflation. If you can't afford to do that for Social Security, tell old folks they'll get wage inflation minus 1%. Remind them that although at age 70 they'll be playing golf and taking cruises, by 90 they'll mostly be sitting around watching TV. And by that time even 60 inch 1080P Pioneer Kuros will be considered so crappy that Walmart will be almost giving them away.
I know that Sumner is being 'provocative' (his words), but he is right on the money. I am actually rather shocked to find another economist who agrees with my views on inflation.
Comments
Mike, you and Scott have some distinguished predecessors. Gottfried Haberler made the same argument in his 1927 book _The Mean of Index Numbers: An Inquiry in the Concept of the Price Level and the Methods of Its Measurement_. E.g.: “The relative position and change of different groups of prices are not revealed, but are hidden and submerged in a general index. Not the movement of the general price level, but the chronological succession of special price and price combinations … are regarded as significant for the waves of business life…. Such a general index rather conceals and submerges than reveals and explains those price movements that characterize and signify the movement of the cycle.”
I agree that the current measures are useless. But the concept isn’t useless. We have the data, we’re just combining it into useless measures.
It isn’t that the concept of the CPI is wrong. The problem is that current CPI-U is wrong. It’s full of things that don’t basically matter.
Not everything changes over time. There are basics that do not change yet econ, with it’s skyhooks, fails to start from the basics.
There is the problem with economists, it misses the basics. It gets all concerned with the price of gold when you can’t eat gold. The Big Mac index is far more important.
Everyone must have ~2200 nutritional calories a day. Everyone must have so much water. This will never change.
Perhaps there are more oranges this year than apples. Perhaps more chicken than beef. The relative price of substitutes changes, but then so does the relative demand. This year, chicken is $1 and beef is $1.50, next year it’s chicken at $1.50 and beef at $1. The demand just switches. If you think you see some problem with this, trust me, you haven’t. Your adding in non-basic issues.
We don’t really need to know what the price of a DVD or movie ticket is. We really don’t care if extra income is being used for fillet minion rather than a round chuck. It’s not important.
And the idea that the CPI doesn’t account for improvements in “quality” is useless. A faster computer isn’t an improvement for grandma that just needs to email her grandchildren. However nifty it is to know what the temperature outside the car is, without opening the door, it’s not an improvement in basic “quality”. More buttons on the remote control doesn’t improve the ability to get the news. HDTV didn’t improve the ability to get the information. A bottle of Scmirnoff will get you just as drunk as a bottle of Grey Goose. These are all things that make it “prettier”, but don’t make it basically better.
We can define a basic standard of living, so much heat, so much roof, so much clothing, so much whatever. The basic amount does not go down, unless we are seriously reducing what is a basic standard of living.
Do we add some basic health care? Are there basics we want to add because society has progressed, sure. Should we reduce them once added? That would indicate a larger problem.
This would be a basic needs price index, CPI-Basic.
What we are interested in is how much of basic needs a person can purchase given their wages.
That is the wage index divided by the CPI-Basic. This is Basic Purchasing Power (PP-b).
If it’s less than one, that’s a problem.
If the basic purchasing power is more than one, well golly, they have money left over for entertainment. An individual can use the extra for whatever they like. They can double the amount of basic goods. They can save it. They can buy a new DVD player. We really don’t care.
Basic needs don’t change. The rest is just extra.
A second thing we are interested in is how much a person is contributing.
That is, the chained GDP divided by the number of employed people. This is, basically, GDP per Working Capita, GDP-WC
It tells us how efficient a person that is working is. It seems to have gone up linearly.
When contribution goes up while the basic buying power goes down, that’s an issue. At least, it’s an issue for me. I keep working harder and better yet reaping no benefit.
These are two solid metrics to begin with.
But, because we don’t track the very basics, the metrics are all over the place.