Greetings, I have a question for anyone who might clarify this for me.
It would make sense if average rise in prices, price inflation, were to be measured by multiplying the price of an individual good or service by the quantity provided, and then summing this number up. It would then be compared to numbers obtained in the same fashion over previous years (or quarters), and from that we could see how average prices have changed in varying goods and services. The quantity and price of each individual good and service consumed should indicate the subjective value these goods appear to have with consumers.
If this is so, then my question for you is, why are indices within the CPI (or any other measure of inflation I’ve heard of) weighted? From what I was told in class, the different weighting represented the proportion of income spent on these goods and services, and how important they are to consumers, but doesn’t the price and quantity consumed already reflect that? Will this not simply lead to a sort of…double counting? Maybe I’m confusing the purpose of weighting…
If I’m right, however, then weightings actually have no legitimate use, and are just there to obfuscate real inflation. Ok I already know that because CPI doesn’t measure most asset prices and seems to underweight everything that fluctuates (responds first to monetary inflation), but I thought that the people who calculate it at least had a valid reason to weight some of the goods and services differently.
I know that Austrians don’t look well on all of these macro-economic aggregates, including inflation, but for the purpose of my question could we just imagine that we’re working within a neo-classical framework.
“The CPI uses an “Expenditure/Chain-Weighted Index”. What this is, is starting with an acceptable premise: goods that are not regularly purchased should carry less ‘weight’ in the CPI index. So bread has a high weight, but wasabi peas do not. This would be fine, but they take this further to the point of fraud. They then added “chain-weighting”, and this means that over time the weighting will change to continue to represent only the most commonly bought goods. This is evil because by the definition of markets, a good that gets more expensive will be bought less and something cheaper will take its place. Therefore, using this system they can effectively hide a huge amount of price level increases. It should be obvious that this is seriously criminal.”
I think the general complaint runs something along the lines, because hamburger patties are cheaper this year than steaks were last year and becuase we can no longer afford steak (thus end up eating hamburger patties) does not mean that the cost of anything (most certainly not the cost of living) has gone down… the only thing that has gone down is our standard of living.
But wait, using your own example of bread and wasabi, does the market data not already provide adequate weighting? After all, if as you say wasabi is less regularly purchased than bread, then the quantity of wasabi purchased on the market will be… less than bread! I don’t understand why any additional weightings are needed besides the market data of quantity and price. But I’ll read that article in more detail anyway, so thanks.
Well if you simply added the cost of everything that the market purchased (price of goods purchased multiplied by quantity of goods purchased) you’d end up with the GDP wouldn’t you? Sure, you could exclude certain goods/services from the calculation but what possible use would the resulting statistic be?
The idea of the CPI is not to calculate inflation however. Since the monetarists themselves recognize that inflation is primarily (if not exclusively) a monetary phenomenon, you have to wonder why they bother measuring prices at all? Why on earth don’t they simply measure increase in the monetary supply? It would be much easier to do and would give them a much more accurate figure for price inflation…
The answer is that the CPI isn’t designed to estimate inflation accurately - it’s purpose is to misrepresent inflation. And if M3 stats were discontinued in 2006 then it’s likely for exactly the opposite reason (that these were a far too accurate measure of inflation).
Yeh you’re right, i’ve been thinking of GDP rather than inflation with that example lol.
Is there any way to accurately measure purchasing power? M3 and other money aggregates aren’t actually that accurate because prices don’t immediately react to inflation. Remember, the purpose of inflation is to fool people. So at first prices will rise by less than inflation. As people begin to expect inflation, they raise their prices by about as much as inflation, and eventually, if the central banks persist in devaluing the currency, a panic resulting in hyperinflation will occur, as in Zimbabwe. On average, over the course of this psychological cycle of getting to grips with inflation, on average, prices should rise by as much as monetary inflation.
I don’t see any particularly fair way to measure average price changes, yet this is important even in the absence of fiat currency. Without fiat, we’d likely see deflation, but in order for credit contracts to go through they would need an accurate knowledge of deflation rates…Then again, can’t we just look at GDP changes in goods and services produced? If money supply is constant, and GDP growth is 2%, then deflation should be around 2%, yes or no?
I think prices probably would rise, over a long period of time, on average, proportionately with monetary inflation, presuming the population remained stable and presuming we lived in a world where there were no government created distortions to how capital gets invested in long term plans. If government gets heavily involved in decisions about how the bulk of peoples savings should be invested then you could end up with situations like Nazi Germany, where quite valuable assets were melted down, destroyed or generally canabalized, essentially just to make lots of weapons. In countries like these the price of food, shelter and other goods could well go up since the resources required to invest in production of these things is being bid away from them by that portion of capital which was acquired by government via taxes or monetary inflation… Even in nations that are not at war, any money that is acquired through tax and inflation will essentially bid resources away from those things most people want to those things the people spending the confiscated dollars want.
Ignoring that though, the description you give of inflation above seems very similar to what Hazlitt is saying when describing velocity (The Velocity of Circulation). He keeps hammering away at the fact that velocity is driven by individual acting human beings and their “perception” about the value of their money (and how that is changing) compared to the value of other goods and services. So when inflation is rife, like in Zimbabwe, people feel quite rightly that their money is practically worthless and becoming more worthless by the second… as a result they try to get rid of it as soon as possible and trade it for anything that will hold onto its value better.
In light of what Hazlitt is saying, it seems to me that exactly how much cash people would want to keep on hand will depend on how valuable they feel each dollar is and what they feel the future holds for them. If they think they’re going into uncertain times, for example, they may want to have a bit more cash on hand (and in cash deposits at the bank) as insurance against those uncertainties they feel they’ll be running into shortly. If people are living in what they feel to be a golden age where high paying jobs are falling out of the sky and they don’t have a problem in the world then they might be much less inclined to hold cash savings. These are two things that might affect their tendancy or reluctance to hold cash reserves and thus the velocity of money… which may very well have an impact on the prices of goods.
It may well be the case that it’s extremely difficult to measure “average price increases”, because prices are the result of far too many complex and interacting phenomena (like how uncertain people feel the future is, and whether they think their money is gaining/loosing value, factors that affect supply and demand such as population increases etc.). If so then I guess forecasting future requirements for money is likely to be yet another realm in which entrepreneurs will come to the rescue - lots will try, some will loose and those who win will have more capital at their disposal to satisfy future human demands/requirements (in this case, human demands for money).
I’d certainly have a hard time believing entrepreneurs would be any worse at forecasting these requirements than the Fed or any other central bank… the CPI and GDP stats that these guys are using quite simply don’t seem to work and I don’t think that’s entirely becuase they simply want to use these numbers to misrepresent the situation (although they certainly do). Lots of people really really want these numbers to work but they are trying to quantify something which is unquantifiable - people’s expectations of the future… that’s essentially why anyone keeps any cash on hand right?