|
Adjusting for quality and size
One of the principles for calculating inflation is that comparisons over time have to be ‘like-for-like’, which creates a problem when the quality of goods changes over time. For example, a family car you purchase today isn’t the same as a family car you’d have purchased a decade ago. Today’s car is likely to be more fuel efficient, safer and have more mod-cons. Looking to the future, you may be able to purchase a car that drives itself within the next decade.
Clearly, the family car of today, yesterday and tomorrow isn’t the same animal (even if it’s still called the Puma, Mustang, Chihuahua or whatever). Simply comparing the prices over time tends to overstate inflation, because part of any price increase can be attributed to the increase in quality (also see the later section ‘Understanding why inflation is usually overestimated’). Statisticians at the ONS attempt to adjust for quality improvements, but doing so is incredibly difficult.
On the other side of the coin, you may have noticed that a number of items in your local supermarket have shrunk in recent years. World food prices have
increased in recent years and a number of companies responded by reducing the size of their products instead of increasing the price! This method could potentially disguise inflation: if your favourite chocolate bar has halved in size but remains the same price, like-for-like it has doubled in price! Again, the statisticians at the ONS adjust for changes in the size of products when calculating inflation, and because the size of an item is easily quantifiable, doing so is much easier than adjusting for quality.
Assessing different measures
Economists use different ways of calculating inflation. In the earlier section ‘Compiling a basket of products and services’, we describe how the main measure of inflation in the UK, the CPI, is calculated. Luckily, the other measures are calculated in a similar way, though some important differences apply too.
Having more than one inflation measure raises an important question: which one is right? The truth is that economists don’t think that one is ‘right’ and the others are ‘wrong’. Instead, the different measures use different methodologies, and one is more appropriate in one situation and another in a different situation.
Here are the three most commonly used measures and some key information about each one.
CPI
As its name suggests, the Consumer Price Index (CPI) is an index. Therefore, the value of the CPI at any point in time on its own isn’t very helpful. What really matters is the percentage change in the index over time: from one year to another or one month to the next.
The base year for the CPI is 2005, which means that its value was set to 100 in 2005. Statisticians chose this year arbitrarily; they could’ve picked any other year without impacting on the rate of inflation from one year to the next. The base year just provides a useful benchmark: for example, if the current CPI value is 130, prices are now on average 30
per cent higher than in 2005.
The CPI purposefully excludes a large component of many households’ expenditure: mortgage interest payments. To understand why, read Chapter 10 on monetary policy. But for this discussion, just bear in mind that if policy makers want to reduce inflation, the key tool at their disposal is to increase the interest rate in the economy. For a number of reasons, this causes the prices of goods and services to fall (or increase by less). But, of course, it also means higher mortgage interest payments. If mortgage interest payments were included in the CPI, it might give the impression that inflation could increase after an increase in the interest rate. To avoid this effect, mortgage interest payments are excluded from the CPI calculation.
RPI
The Retail Price Index (RPI) is a much older measure of inflation than the CPI. In the UK it has been calculated since 1947 (with a current base year of 1987). In comparison, the CPI is a relatively recent measure going back only as far as 1996. Unlike the CPI, the RPI does include mortgage interest payments. Other items included in the RPI but not in the CPI include charges for financial services.
Historically, policy makers have used the RPI for a number of purposes, including the indexation of pensions (so they don’t lose their real value), in wage negotiations and price increases in regulated industries. The RPI continues to be an important economic statistic, although its importance has diminished in recent years in favour of the CPI.
One of the reasons for the preference for the CPI is that many countries use it to calculate official inflation statistics. Therefore, comparing inflation across countries is easier with the CPI.
Another widely used measure of inflation is the GDP deflator (check out Chapter 4 for all the gen on GDP). The GDP deflator is calculated in a quite different way to the CPI and RPI, because it uses the already available data on nominal GDP and real GDP in order to infer the rate of inflation.
As we describe in Chapter 4, real GDP is the total value of goods produced in a year using constant prices, and nominal GDP is the total value of goods produced in a year using current prices. By definition, they’re equal in the base year.
Imagine that the base year is 2000 and that real and nominal GDP at that time equalled £1 trillion. Suppose that in 2001, real GDP comes in at £1.02 trillion and nominal GDP at £1.03 trillion. Can you say anything about how much inflation occurred between 2000 and 2001? Well, yes you can: nominal GDP has increased over the year by 3 per cent, potentially due to two factors:
Actual amount of goods and services produced increased: That is, real
GDP growth happened.
Average price level increased: That is, inflation occurred.
The real GDP figures are available for all to see, so you can quite quickly tell that because real GDP increased by 2 per cent (from £1 trillion to £1.02 trillion), inflation must have been approximately 1 per cent in order to give a nominal GDP increase of 3 per cent (from £1 trillion to £1.03 trillion).
Extending this logic, the GDP deflator is defined as follows:
This equation essentially creates an index that equals 1 in the base year. If inflation exists, nominal GDP increases by more than real GDP, which raises the level of the index. Similarly, deflation lowers the value of the index. If the index remains unchanged, the price level is unchanged, because nominal GDP and real GDP have increased by the same proportion. The percentage change in the GDP deflator from year to year is the rate of inflation that year.
A nice thing about the GDP deflator is that when you have data for nominal and real GDP, calculating it is straightforward – you don’t need to go out and survey all the prices in the shops and so on. One major limitation, however, is that the GDP deflator picks up inflation only on domestically produced goods and not imported goods.
Do'stlaringiz bilan baham: |
