"Inflation Means Prices Are Higher Than They Used to Be"

One of the advantages of being very slow to finish off my inflation manuscript is that I can add content as things pop up. This section is an edited draft that was added in response to a recent Felix Salmon article.

One argument that came up as I was finishing this manuscript is that there has been a linguistic drift in the word “inflation.” In the article “’Inflation Doesn’t Mean What is Used To,” Felix Salmon argued that in popular usage, the meaning of “inflation” has drifted to mean: “[A]m I paying higher prices for things than I used to?”

Although Salmon’s article (correctly) predicted that economists’ responses to this suggestion would be negative, he argues that they are out of touch with the common usage of the term. Since this book intends to properly explain the concept of inflation, there is no way I could use such a definition, since it has obvious shortcomings. (As he noted, prices could be falling, but this would qualify as “inflation” so long as prices were lower at some previous point in time.)

If we rely on what prices are stuck in people’s memory, the results can be dubious, since the comparison points are arbitrary. My personal example is when I visited the United Kingdom in 2022 and compared the prices of chocolate bars to the price in the department vending machine in 1992 (22 pence, or 23 pence for the premium bars). (That price stuck since I used to feed my 1p and 2p coins into the vending machine to get rid of them.) The fact that prices were indeed lower 30 years previous is not providing much information about current trends in the U.K. economy.

Although I have doubts that this new usage would get traction – any serious economist or financial market commentator is not going to use it – there are a few arguments that seem reasonable.

1.      Salmon highlights that the use of the change of the price level over one year is arbitrary. However, using the one-year percentage change has major advantages over alternative time frames (discussed below). People write “inflation” or “inflation rate” instead of “annual inflation rate” because it is less wordy.

2.      Most people in developed countries at present do not have a good grasp of what the overall inflation rate is, and mainly look at the level of prices of a handful of goods (gasoline, groceries). They will then compare current prices to some conveniently lower price that occurred some time in the past. However, I would argue that is a side effect of the low inflation regime – back in the 1970s, people had a much stronger grasp of inflation since they dealt with increasing inflation rates over a multi-year period. The fact that people apparently paid money to a website that claimed that inflation was “really” several percent higher than official statistics is a sign that many people do not have a good idea what the inflation rate is.

3.      Although not noted in the article, people’s perceptions of inflation seem to be partly driven by the editorial agenda of the business press. It is not entirely an accident that the Republican-leaning business press got extremely excited about inflation during the presidential term of a Democratic President.

The preference for the annual rate of change of inflation is easily explained. The first is that it eliminates seasonal effects. The second is it easy to calculate – how many people would know how to properly calculate the annualised rate of inflation over periods other than one year? The final reason is that the one-year rate of change seems to capture changes in economic trends. Annualising 3-month percentage changes creates massive swings in the inflation rate that are misleading (particularly with data that has seasonal adjustment problems or even unadjusted). A two-year annualised inflation rate (or longer) might be useful for historical analyses (what happened over a certain period?) but moves too slowly to capture changes in economic trends. Although it is not clear that a 12-month window is “optimal,” it is the easiest one to understand. (Why would you look at the annualised percentage change over 9 months?)

Although it is safe to say that the popular perception of inflation is quite often at odds with official inflation, it seems unlikely that changing the definition of inflation would help matters.

Reference:

• “’Inflation Doesn’t Mean What is Used To,” Felix Salmon, May 26, 2024. URL: https://www.axios.com/2024/05/26/inflation-definition-evolution-high-prices