9 October 2011

Real Inflation? (Part 1)

At a recent lunch the conversation turned to how most American's real income hasn't change since the 1970s when we adjust for inflation (see here for some decent graphs). One of the people at the lunch (a person who has written considerably on monetary policy) contested this. His argument is that we are actually very bad at measuring inflation. Prices may rise, but the quality of the goods that we buy is much better now than it was in the seventies. The iPad I buy now is much better than the 1970s TV or radio or all the other things that it replaced in my life and probably cheaper than all of these things combined. On this line of reasoning, inflation is actually overestimated.

There is one obvious flaw with this argument: it misses much of the point. If we were really terrible at measuring inflation in this way, then yes maybe most peoples' income has actually increased. But the bigger issue is that the top sliver of the income distribution has made steady gains since the 1970s even using this potentially underestimated measure of inflation. If we are underestimating the gains for most people we are also underestimating the top part of the distribution's large gains as well. Reinforcing the point.

Ok, but what about this idea that we underestimate inflation because we have a difficult time correcting for improvements in the goods that people buy. Maybe there is something to this, which I'll follow up on later. . .

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