David Leonhardt on the "True" Inflation Rate

I'm not sure that it is (now) overstated by much, but I think he's right in his claim that inflation is not understated--at least not if you have tastes for high-tech toys:

Seeing Inflation Only in the Prices That Go Up: Next week, the Bureau of Labor Statistics will release its monthly report on inflation... that the Consumer Price Index rose just three-tenths of a percentage point in April. Over the last year, the index has risen only about 4 percent.

I’m guessing that doesn’t square with your sense of reality.

In my household, we just broke the $60 barrier for filling up our gas tank... the price of bananas is up almost 20 percent... eggs are up 35 percent. Costco and Sam’s Club recently began rationing rice... big-ticket items that have been getting more expensive for years — like health care and college — just keep on getting more so.

This contrast between the official government statistics and day-to-day reality has led to a boomlet in skepticism.... [W]hat’s going on here?

To answer that question, it helps to go back.... In 2003, a pound of hamburger cost all of $2.20. More than two decades earlier, in 1980, it cost $1.86, which means that the nominal price of burger meat rose only 18 percent over a period in which the nominal hourly pay of the typical American worker rose 150 percent. Similar stories can be told about eggs, bananas, bread and frozen orange juice. Food was getting cheaper.... During the 1980s and 1990s, though, did you ever stop and marvel at what a small share of your paycheck you were spending at the supermarket? I didn’t. I also didn’t really notice that gas cost less in the late 1990s than it had in the 1980s.... Price increases are simply more noticeable — more salient, as psychologists would say — than price decreases....

The price of major appliances has been flat over the last year. Furniture is 1 percent less expensive. A decade ago, a basic four-door Toyota Corolla LE cost $16,018, according to the company. The 2009 basic model costs $16,650, and it’s a safer, more powerful, more fuel-efficient car than its predecessor....

The conspiracy theories about inflation play off these human instincts, but they also depend on two other oddities. The first is the amount of attention given to the so-called core inflation rate. This is a version of inflation that excludes food and energy, which makes it a little like a grade point average that excludes math and French.

The core inflation rate does have a purpose... [to] help Federal Reserve officials base interest rates on underlying price trends, instead of being overly influenced by food or gas prices, both of which can be volatile....

The final piece of the puzzle... is the way that the Bureau of Labor Statistics has changed the price index recently.... [E]conomists who have studied the changes say they have had only a modest effect on the inflation rate, lowering it by perhaps a half point a year. More to the point, the changes seem to have made the index more accurate than it used to be. “It’s about as accurate as anybody is going to get it,” Mr. Cecchetti said...

Comments

[jerry]

"I'm not sure that it is (now) overstated by much, but I think he's right in his claim that inflation is not understated--at least not if you have tastes for high-tech toys:"

Terrific. If you're rich, than inflation has not hit your new car, new furniture, new appliances much at all.

And if you're poor and don't know what a new car looks like, are sitting on broken chairs, with 20 year old inefficient appliances, ....

I think that it does make sense to discuss inflation in terms of how it impacts the rich and not the poor.

[anne]

http://www.irinnews.org/PrintReport.aspx?ReportId=78100

May 8, 2008

High Prices, Low Wages Feed Violent Political Stand-Off
By IRIN

BEIRUT - Ramzi Ali was nearly 13 when his parents took him out of school to work as a motorbike mechanic.

"Conditions are hard, and political tensions are destroying the country," said Ali, now 14, as he manned a barricade of burning tyres in central Beirut on 7 May. "My parents just couldn't afford to keep me at school any more."

Anti-government protesters blocked roads with burning tyres across the Lebanese capital on 7 May after Iranian- and Syrian-backed Hezbollah, and an allied Christian party, threw their weight behind a general strike called by the country's union federation to demand higher wages and decry high prices.

A pall of smoke hovered above a city of shuttered shops and empty roads, as workers either obeyed the strike call or stayed at home for fear of the sectarian violence that flares up periodically in Beirut and stokes fears of civil war.

Gunmen exchanged fire in central areas of Beirut that are mixed Sunni and Shia Muslim, and therefore divided between supporters of the Sunni Future Movement, part of the pro-Western governing coalition, and the Shia opposition Hezbollah and Amal parties.

The strike was called by labour unions after rejecting a last-minute government increase in the monthly minimum wage from US$200 to $330. Recent research by Lebanese economic consultancy InfoPro found that wages averaged $500 while the actual minimum wage was around $320, making the increase irrelevant to most workers.

Prices up

A grocer in Ras al-Nabeh neighbourhood of Beirut said a bottle of cooking oil had risen from $4 to $6.5, while the price of sugar had doubled. Where one dollar used to buy 1.5kg of bread, it now buys 1.1kg. Chickpeas and grains that are a staple of Lebanese diets, meat and vegetables have also risen.

According to the consumer association, prices have risen by 43 percent over the past 21 months, while the official unemployment rate stands at 10 percent. Independent estimates put it at 20 percent.

Central Bank Governor Riad Salameh also said last week that the inflation rate had risen by 10 percent, due to a rise in oil prices on international markets, food prices and the weakening of the dollar against other currencies.

Personal testimonies

Mahmoud, an unemployed 20-year-old at the barricade who preferred not to give his full name, said rising prices and low wages made it harder for young men to get ahead.

"At this rate, I'll never get married," he said. "You have to work several jobs at once just to make ends meet, and it's hard even to find one… Women don't want to marry a man who can't afford even to rent his own home," he said.

Both young men, who said they were Hezbollah supporters from the mainly Shia Muslim southern suburbs of Beirut, blamed the government for Lebanon's worsening living conditions.

"Every time we protest about price rises and low wages, or the policies of this government that's on Western life-support, we're told we're stirring Sunni-Shia strife," said Mahmoud.

Because the strike was associated with the opposition, some government supporters were showing their defiance.

In a pro-government part of the eastern area of Achrafieh, Raymond Charbel, a 68-year-old father of three, defied the strike to keep his run-down dry-cleaning shop open despite the dearth of customers.

Food to feed his family had become harder to afford, he said, saying lemons - much used in Lebanese cooking - had more than doubled from about $0.75 a kilogram to $1.75. "Inflation and economic ruin is affecting everybody, so what good is closing down the roads so no one can work?" he asked....

[anne]

"I'm not sure that it is (now) overstated by much, but I think he's right in his claim that inflation is not understated--at least not if you have tastes for high-tech toys...."

Or, computer chip for lunch?

[anne]

"I'm not sure that it is (now) overstated by much, but I think he's right in his claim that inflation is not understated--at least not if you have tastes for high-tech toys...."

Or, the neo-populism.

[Bruce Wilder]

A market-basket price index is a linear approximation of a non-linear trend. Ultimately, accuracy is not really a quality that a price index can claim.

As a statistic, a price index claims to have a functional relation to the underlying sampling of prices, and objective integrity, not "accuracy", is the paramount virtue of such a statistic. It is not a virtue, which can be claimed for the CPI, as currently constituted.

[George Smiley]

"During the 1980s and 1990s, though, did you ever stop and marvel at what a small share of your paycheck you were spending at the supermarket? I didn’t."

Really? (Gasps.) Really? If he is not being facecious, then David Leonhardt is the type specimen of a man who knows the price of everything, and the value of nothing.

[Kelly]

Housing? Medical care? ?????

[Darren]

George, forgive me for being dense, but what does your comment mean? The observation that food prices were low relative to incomes in the 90s (or at least, lower than they are now) is a valid one, it seems to me.

I'm a single man who likes electronic toys and rides a bicycle everywhere. (granted, I'm a minority). Yes, I do eat, but that's a relatively small part of my budget and has always been. For MY basket of goods, inflation has been strongly negative for years. The hedonic improvements of my favourite toys (computers, musical instruments, etc) which constitute much of my consumption have been nothing short of stunning (10Mbps internet, anyone?). The CPI 'basket of goods' is an average... not everyone spends half their income on food and fuel.

That being said, I'd like to learn more on how the CPI basket is constructed and weighted. The composition of the basket is publically available, I wonder what would happen if one constructed alternative baskets for different socioeconomic groups?

[thorstein veblen]

Brad, I'm curious why you don't think the CPI understates inflation. When I buy a cup of coffee these days, I get wireless with it. With that, I can read your blog (for free), choose between listening to about 2 billion songs (for free), read almost any world newspaper, or download almost any movie from the bootleg chinese sights, all for absolutely nothing. Slap market prices on what all of that would have cost back in 1980, and you'd be north of $100K easily... all for $1.50 cup of coffee...

Granted, my Grandma cares mostly just about her rent and utility payments, as she doesn't own a computer or Internet. Perhaps the Fed should be more worried about inflation which affects my grandma, but Growth economists should be focused on the true inflation rate -- which takes a weighted average of goods and services based on what they would have cost before competitive price collapses...

During the classic IR in Britain, the price of cotton textiles decreased five-fold. If consumption increased five-fold, it would be stupid to call that no change in the size of the economy... And now, every time I watch a youtube video for free, that should enter GDP. It does not...

[Blissex]

«That being said, I'd like to learn more on how the CPI basket is constructed and weighted. The composition of the basket is publically available, I wonder what would happen if one constructed alternative baskets for different socioeconomic groups?» There are as many inflations as there are buyers, that is baskets of goods. However the original purpose of the CPI was to measure the evolving cost of a working class standard of living. The rationale was that a lot of strikes during high inflation are caused by workers trying to protect their standard of living in the face of raising prices. By automatically protecting working class standards of living, that cause of strikes is removed which helps quite a bit. Also, widespread inflation proofing was expected to reduce the incentive to raise prices to gain relative advantage. The reason why the inflation proofing of working class standards of living has been eroded by a series of redefinitions of the related index is very simple: the working class no longer strikes, and employers and the politicians and economists that they sponsor obviously hate giving something away for "free".