If you’re like many Americans, you may find the recent economic news somewhat perplexing. Government reports show the economy improving and inflation under control. And yet, it may well feel as though your standard of living is eroding, and you may be shocked by prices when you go shopping. Well, there’s a reason for any disconnect between the official statistics and your own experience – and much of it has to do with the nature of inflation.
The fundamental problem is that people – economists and laypeople alike – talk about inflation as though it can be measured accurately and represented by a single number. In reality, though, inflation is a judgment call and varies enormously depending on what part of the economy is under consideration. The inflation figures that economists use when they calculate statistics can differ enormously from what you experience at the grocery store. In fact, you could say that every person has his or her own individual inflation rate.
These discrepancies have been highlighted in recent weeks as various authorities reported economic statistics for 2011. The Consumer Price Index rose a modest 2.9% over the past 12 months. On the other hand, a report on Thursday by an independent research organization calculated that prices of “everyday items” rose more than 8% last year.
The latter report, on everyday prices, by the American Institute for Economic Research, an organization with free-market leanings that originated at MIT in the 1930s, was particularly interesting in its details. On the plus side, there were double-digit price declines for televisions and computers, while some other kinds of consumer electronics declined at single-digit rates. But those improvements in affordability were massively overshadowed by the big price increases in 2011: Meat and milk rose more than 9%; coffee was up 19%; and peanut butter, a staggering 27%. Heating oil climbed 18%. Children’s clothes were up 6% for boys, 9% for girls. Gasoline rose almost 10%.
In short, American consumers are experiencing 1970s-style inflation unless they sit home all day in old jeans and sweaters, doing nothing but surfing the Internet. Fortunately, cookies are up only 3.2% and beer, 1.4%, so there’s something affordable to eat.
And even those figures are only averages. Inflation is higher for the affluent (who at least can afford it). Indexes of luxury goods climbed anywhere from 6% to 15% last year. More serious, inflation for people age 62 and older is typically as much as two percentage points higher than the overall CPI, in part because of medical expenses.
This enormous variability in the inflation rate filters through to other economic statistics, as well. So-called real growth in the economy or household incomes is calculated by subtracting inflation from figures in today’s dollars. The smaller the inflation adjustment, the higher real growth will appear, and the larger the inflation adjustment, the weaker real growth will be.
Indeed, the reported economic upturn in the fourth quarter can be attributed almost entirely to an unusually low inflation adjustment. Most measures show consumer prices rising at close to a 3% annual rate, and the inflation adjustment for GDP growth was at least 2.6% in each of the first three quarters of 2011. But in the fourth quarter, the inflation adjustment used to calculate real GDP was less than 1%. If fourth quarter growth had been based on the same inflation rates used earlier in the year, there would have been no upturn – already weak growth would have slowed further between the third and fourth quarters.
A handful of conspiracy theorists have suggested that the numbers were rigged in Washington because an election is coming up. I doubt that. There may be valid reasons that inflation in the industrial economy measured very low for the fourth quarter. But that doesn’t necessarily reflect your own personal reality. For example, workers’ real incomes have risen slightly in the past few months, according to government inflation measures. But if those workers face continually rising prices at the grocery store and elsewhere, their own experience will be that the recession has not ended and that their standards of living are still falling.
Some commentators have tried to make current conditions sound rosier by pointing out that prices of a few key big-ticket items are falling, offsetting the price rises on everyday items. This argument is faulty for two reasons. First, big-ticket items such as housing and autos are highly cyclical. Their contribution to long-term inflation depends on their trend over time, not on temporary lows near an economic trough. Second, people don’t buy cars and houses every day. Your monthly budget isn’t affected by what you might have paid for your home some years earlier. Indeed, this underlines the extent to which your own inflation rate depends on your personal circumstances. A renter might be affected by price trends in the real estate market, but someone with a long-term fixed-rate mortgage wouldn’t be.
There are, in fact, multiple difficulties in trying to account for cyclicals and highly volatile items such as oil when measuring inflation. But insofar as such things can be assessed, they suggest more inflation in the future, not less. Depressed home prices will likely rebound at some point if the economic recovery gains momentum. And current high oil prices will eventually factor into inflation as transportation costs get passed along for many goods.
In the final analysis, what matters most to you is your own personal experience of the economy. And you’re probably feeling higher inflation and weaker growth than the economic statistics coming out of Washington would suggest. If you really want to know what’s happening to your own standard of living, go to the nearest grocery story or department store – and simply look around you.