The Inherent Ambiguity Of Inflation

Virginia Postrel writes about the difficulties of doing quality-adjustments for the purposes of calculating the Consumer Price Index. Something that I think often goes missing in these discussion is that this is fundamentally not a measurement problem. It’s a deep conceptual problem that’s totally unsolvable. Consider cases of quality deterioration. Nowadays to get the best prices in a supermarket, you need to swipe your loyalty card. This seems to bother Kevin Drum a lot and it bothers me not at all. So who’s “right” about this? Neither of us, obviously, and there’s thus no “right” answer to how the quality disamenity should be measured.

By the same token, something as seemingly quantifiable as a change in available legroom on airplanes turns swiftly turns into a series of ill-defined idiosyncratic preferences. How tall are you? For what purposes are you flying? What’s the state of your joints? The best way to think about CPI calculations is as an effort to solve a very practical problem. Social Security benefits (and the like) need some kind of annual adjustment that neither breaks the bank nor guarantees ever-falling living standards for elderly people. So we have an effort to construct a statistical series that will meet those goals. And it works pretty well. But don’t reify the concept of an inflation rate and then worry about whether or not the government is “really” calculating the “real” one. Things change in a lot of ways, preferences are heterogeneous and aggregating it all up into a single number is inherently wrong. It’s just that the programs need a single number.

I think this is something that should be kept in mind as the NGDP targeting debate continues. Because the phrase “real GDP” contains the word “real” and because inflation targeting is customary, it’s easy to think of NGDP as something weird that’s constructed of real output plus inflation. The truth is the reverse. Nominal output is something that’s directly measurable. Inflation is a product of a bureaucratic process. And “real” GDP is just nominal GDP minus the output of the bureaucratic process. If bulk commodities (oil, coal, wheat, rice, corn) constituted the bulk of economic output, you might say this isn’t the case. You can measure the quantities of commodities produced and also the prices charged. But the actual American economy isn’t like that. There’s not a fact of the matter about whether the more expensive hairstylist is “really” better than the other one.