“In many spheres of human endeavor from science to business to education to economic policy, good decisions depend on good measurement.”
From 1975 through 1982, inflation was the single most addressed topic in the Wall Street Journal (and I’m sure in virtually all other business media at that time). We have now gone over a generation barely mentioning it until this year. The resurgence of inflation numbers this spring has caused much angst. Is it a temporary phenomenon, as some believe, due to COVID, reflecting jammed up supply chains as the economy reopens? If this is the case, the “inflation” is not really inflation! Or, is it the beginning of a more persistent threat due to massive government spending and Fed accommodation, as others say? We’ll leave that question until another day. In the meantime, just what do the inflation numbers (up 5.4% in July, for example) mean?
In theory, inflation is easy to define: it is a general (not product-specific) rise in the price level owing to more money chasing a static or slower growing supply of real goods and services. In practice, measuring it is diabolically difficult. And translating what is measured into the effect on real consumers is almost as hard. A recent article in the WSJ noted that excluding housing, food, transportation, and tobacco products, “core” inflation is not up nearly as much as the headline numbers suggest. Okay, so if you are hungry, homeless, don’t go anywhere (and don’t smoke!), inflation is not a problem. Hmm.
Technically, measuring inflation is fairly simple: economists measure the cost of a sample (or “basket”) of goods and services at two points in time and the difference is “inflation” (or deflation if the cost of the basket has decreased). In reality, it’s much less simple!
First of all, in reality we don’t buy the same “basket” of goods time and time again. In the short run, consumers make substitutions based on the very price changes being measured; if pork prices are up more than chicken, people buy more of the latter. In the longer run, we buy different collections of goods as we age, begin families, retire, etc. The ”inflation” felt by millennials could be very different than that faced by aging boomers.
More troublesome still is accounting for changes in product quality and technological advances. A recent trip to an antique auto show (I really hate calling cars I bought and drove “antiques”!) provided a stark example. A well-appointed 1970 domestic sedan (like a Chevrolet Impala) cost about $3500 then; its 2020 equivalent about 10x more. But, in 1970 they didn’t have all the safety features (multi-point seatbelts, air bags, door reinforcements, headrests, crumple zones, collapsible steering columns, rear and side cameras, lane-departure warning systems, automatic braking, low tire pressure sensors, rear-window defrosters, run-flat tires, On-Star), the comfort features (powered adjustable seats - heated and/or cooled with lumbar supports, zoned A/C, multi-speaker AM/FM/Satellite radios, DVD players, power windows, adjustable steering wheels, cup holders, power outlets, keyless entry), and lots of other stuff (GPS navigation systems, cruise control, clear-coat paints, automatic headlights, tinted glass, sunroofs, compasses, temperature readouts, engine readout sensors). How much of the price change between the two cars is inflation and how much is innovation? The same goes for many other products, and over shorter time spans.
All that said, just because it’s hard doesn’t mean we shouldn’t do it. But it does put in perspective the interpretation of the numbers: In the short run, is a reported +5.4% really different than +4.7%, or even +2.4%? The “accuracy” of the numbers is comforting but misleading. As consumers and investors we shouldn’t get too excited about the numbers from month-to-month or quarter-to-quarter. Over the next few years we’ll know (as we did in the mid-70s) if the Fed has over-amped the money supply and we’ll sense the inflation sure enough, even if we can’t measure it exactly.
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