It’s Time to Talk About Something and Inflation Isn’t the Right Word for it

Inflation is on everyone’s mind these days. It’s in almost every markets conversation. How bad is it? Who is getting hit by it? Is it transient? What does transient even mean? What is its impact on markets and the Fed? 

But there’s another aspect to this discussion, which feels like inflation, but which is about something very different that also needs to be discussed.

Alex Williams, (who recently wrote an Odd Lots blog guest post) has a piece arguing that national inflation statistics are largely meaningless to most people. We talk about, say, the Consumer Price Index as a macro indicator. But it’s just a bunch of prices of often-unrelated things added up, and the end result is usually something that doesn’t actually give us much insight, and is frequently disconnected from the experiences of normal people: get something that you can get a handle on, you have to spin up a consumption basket. The idea is that, if you track movements in the price of a handful of things that people usually use their money to buy, you can get an estimate of “inflation” in the large and in the main. The Consumer Price Index (CPI) does this in the US by looking at movements in the price of a basket of goods in different cities, and weighting them accordingly. They even have Secret Shoppers who go in and check the price on a gallon of milk, or a bacon egg and cheese, or a lawnmower. Honestly seems like a fun job. The Personal Consumption Expenditure (PCE) measure of inflation is a little different, because it relies on statistics collected about how much people actually spend by category, rather than what stores price goods at, and aggregates and weights differently. Everyone nowadays looks at these two most of the time, and a lot of arguments wind up being over the correct window of CPI to use, or whether Core PCE is better than plain old PCE because it strips out certain noisy series.

The trouble is, it’s hard to really make these measures mean anything to anyone except inflation cranks and a couple hundred people at the Federal Reserve. No normal person, in their real life, feels a 15 basis point move in CPI or PCE. People who make their living modeling, expecting, and trading these moves do, but that is really not a large part of the economy.

Alex goes on to talk about a project called the Cost of Thriving Index, which came out last year and attempts to demonstrate how the standard of living of a middle-class family has declined over time, or become less affordable. An intuition many people have is that they have to work longer, in more tenuous conditions, for a middle-class standard of living that’s worse than what their parents had before them. And in many cases that intuition is probably true.

The problem is this is not necessarily inflation per se.

As Brian Romanchuck, the author of the Bond Economics blog, recently wrote, cost of living and inflation are two concepts that are worth keeping distinct. And attempting to measure the trajectory of “what it takes for a middle class family to own a house and a car” is not the same as measuring inflation.

This is the key paragraph:

Whether or not wages rise faster or slower than the prices of goods and services depends upon their bargaining power of firms, as well as institutional factors (minimum wage rate setting, etc.). To what extent workers’ standard of living has fallen behind in recent decades, we need to look at the overall structure of capitalist society. This is a complicated question – and the answers may depend upon the country. In any event, trying to pin the blame on “inflation” is just a way to deflect attention away from policy failures. (From my perspective, I think the living standards story is more mixed than many critics suggest.)

In other words, a decline in middle-class fortunes could theoretically be due to inflation. But it could also be due to some other phenomenon, such as a decline in labor bargaining as a result of falling unionization. Or it could be related to changes to the welfare state. So to just chalk it all up to “inflation” is attempting to do much with such a difficult thing to measure. There are lots of things going on in the economy and the composite of prices is just one of them.

I recently did an interview with Rachel Premack, the author of the Modes Newsletter, and I noted that one of the things going on in the economy right now is that certain services and goods enjoyed by parts of the urban middle class feel like they’re getting more scarce or expensive right now. Lots of people have complained about how expensive Uber rides have gotten, just to name one example. And we know that various fast food and other service establishments have complained about how hard it is to hire. On the other hand, wages have grown rapidly at the low end, and so what might look like inflation to one group within society could be an improving standard of living, and an easier cost of thriving, for another group in society. And again, trying to come up with one number that’s going to capture all this in aggregate, for purposes of better monetary policy, is going to be really difficult.

And so obviously we’re going to keep talking about inflation and CPI and all that. But also a lot of the discussion should be about bargaining power, the relative status of various groups in society and other structural changes that may or may not be permanent in the post-pandemic economy. Calling it all inflation, because certain goods or labor might be more scarce, might end up being a distraction from what’s actually going on. 

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