Wednesday, August 2, 2017

Inflation in the Modern Age

Life used to be pretty simple.  Folks paid rent or mortgage payments, consumed food and energy, and paid their taxes.  Measuring inflation was relatively simple.  One simply checked on average rents (or mortgage interest rates, food prices and energy prices.  Tracking these simple numbers gave a straight-forward estimate of the cost of living.  That was then, but no longer.

Today, 95 percent of Americans have cell phones and almost 80 percent have a desktop computer or a laptop.  The government's calculation of the cost of living ignores these items, yet they have become an increasing portion of every household's budget.  Are these new technology-based products exhibiting price increases?

What about the cost of transportation?  Do taxi fares tell the story?  What about Uber?  Sometimes, only an Uber driver can be found -- no taxis anywhere in sight?  The cost of a taxi at such times is infinite.  Uber might be expensive in such situations, but less expensive than the non-existent taxi.  How about lodging?  How does Airbnb factor into lodging expenses.  Is their price inflation here?

Remember that the quality of the product is supposed to be held constant when estimating inflation.  Is today's cellphone or laptop of the same quality as what was available ten years ago?  What does using Uber and Airbnb cost?  How do such costs compare to ten years ago?  (No way to know).

What about Amazon's Alexa and Echo?  How does the CPI account for these new products and services?

It is not at all clear that current measures of inflation have anything much to do with the theoretical notion of inflation.  The concept of inflation is based upon the idea that the currency changes its value.  Inflation is the falling value of a currency.  The rate at which a currency loses value is the definition of inflation.  "Loses value" against what?  Aye, that is the rub.

What households consume has changed dramatically in the last several decades and households are much, much more diverse in their spending patterns -- drug use (that something is illegal to consume is irrelevant), technology products, new entertainment devices (think Netflix) were not part of the mix just three decades ago.  But, now they are.

So far, economists have ignored these complications.  But macroeconomic policy crucially depends upon the measurement of inflation and expectations of inflation.  It is no longer clear that we have any idea how to do that.  That is part of the reason that monetary policy is more "witchcraft" today than anything based upon scientific considerations.

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