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“Why it is so difficult to measure inflation

Tisk it or drat it, this task still takes a basket”

explain what the best method to calculate the cost of livingis, and what challenges still exist with it.

Why it is so difficult to measure inflation

Tisk it or drat it, this task still takes a basket

BRITAIN introduced its first index of the cost of living in1914. It has gone through plenty of iterations since then. Theretail-prices index was introduced in 1947 and a consumer-pricesindex came into being in 1996. Most recently, in March 2017Britain’s statistics office introduced a new headline measure ofinflation, the “consumer-prices index including owner-occupiers’housing costs” (CPIH), which includes the specific costs of owninga home, such as mortgages and estate agents’ fees. The update makessense: after all, about 15% of household spending in Britain goeson owner-occupied housing. CPIH may be ultra-sophisticated(statistical agencies in other countries struggle to incorporatehousing costs), but like all inflation measures it remains animperfect measure of changes to Britain’s living standards.

At its simplest, inflation is a measure of how quickly pricesincrease. To estimate the figure, statisticians choose what theybelieve to be a representative “basket” of goods and servicesconsumed by the population. The figures are usually expressed interms of the percentage change on a year earlier. If all thatsounds simple, it is not. First there is the question of what toput in the basket. Consumption habits change all the time and wonksmust estimate what to put in the basket through surveys onhousehold spending. Britain updates its basket once a year, so itis likely to be fairly representative (this year, gin and cyclinghelmets were added; menthol cigarettes were out). But America onlydoes so every two years, and used to do so every ten. At the sametime statisticians must account for the fact that the quality ofthe basket often improves. This year’s smartphone might cost morethan last year’s, but it will also do more. If statisticians focusonly on changes in price, they will overstate the true inflationrate by missing improvements in performance. An advisory committeeset up by America’s Senate in the mid-1990s reckoned that thefailure to adjust for quality and new products meant true inflationwas overstated by at least 0.6% a year.

A single measure of inflation cannot reflect the differentcost-of-living changes faced by different sorts of people. Forinstance, London has seen rapid increases in house prices eachyear, yet since CPIH is a national figure, the inflation faced byLondoners may be understated. There is also a rich-poor divide. Themethod of constructing an inflation index is often described as“plutocratic”, rather than “democratic”. In other words, the choiceof what to put in the basket is skewed by what rich people buy,since rich people spend more. (So if a rich wag decided to spendbillions of pounds all in one go on, say, shoehorns, then in theoryshoehorns would make up a big chunk of the inflation basket thefollowing year.) This can mean that rich and poor folk experiencedifferent inflation rates. For instance, poor households spend moreof their budgets on food, and in the 2000s food prices were risingquickly. One paper found that from 2003 to 2014, the averageinflation rate for those in the bottom income quintile was 3.4%compared with 3% for the top quintile.

It is not easy to get around any of these problems. Britain’sstatistics office has mooted introducing regional indicators, aswell as stratifying inflation by income. Yet even with thesechanges, inflation will remain a fuzzier measure than is commonlyacknowledged.