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Inflation: Reality vs Official Governmental Estimates

From time to time here at MFO we have discussed the easily observable reality of ever-smaller packages and, at least in some cases, decreasing quality, vs the seemingly disconnected governmental inflation figures. The argument advanced for the accuracy of the governmental figures tends to rely on an assertion that the official "yardstick" has not varied over time, and is therefore dependable.

An article from The Economist presents an interesting perspective on why the official figures are frequently divorced from the reality at your supermarket checkout stand.

Following are selected excerpts from that article, edited for brevity. All italic and bold editorial emphasis has been added.
Two yeas ago as sterling tumbled, global firms selling chocolate to the British market faced the same production costs as before, but got less money for each sweet sold. Rather than raise the price per chocolate, some chose to shrink the chocolate per price. The famous peaks on a bar of Toblerone grew conspicuously less numerous. Other products suffered the same “shrinkflation”: toilet rolls and toothpaste tubes became smaller. The threat of Brexit made the phenomenon more visible, but it is surprisingly common. Statisticians and policymakers need to take note.

Every first-year economics student quickly becomes familiar with charts of supply and demand, which place price on one axis and quantity on the other. Given a drop in demand, the charts show, firms can either sell fewer items at the prevailing price or cut prices to prop up sales. But online retailing, which makes it easier to collect fine-grained price data, reveals how poorly textbook models reflect real-world market dynamics. The prices of consumer goods, it turns out, behave oddly.

A forthcoming paper by Diego Aparicio and Roberto Rigobon of the Massachusetts Institute of Technology helps make the point. Firms that sell thousands of different items do not offer them at thousands of different prices, but rather slot them into a dozen or two price points. Visit the website for H&M, a fashion retailer, and you will find a staggering array of items for £9.99: hats, scarves, jewellery, belts, bags, herringbone braces, satin neckties, patterned shirts for dogs and much more. Another vast collection of items cost £6.99, and another, £12.99. When sellers change an item’s price, they tend not to nudge it a little, but rather to re-slot it into one of the pre-existing price categories.

Just as surprising is how rarely [prices] move at all. Retailers seem to design products to fit their preferred price points. Given a big enough shift in market conditions, such as an increase in labour costs, firms often redesign a product to fit the price rather than tweak the price. They may make a production process less labour-intensive—or shave a bit off a chocolate bar.

Central banks are starting to see the consequences. Inflation does not respond to economic conditions as much as it used to.

When the price of everything rises a lot year after year, as in the 1970s and 1980s, firms can easily adjust the real, inflation-adjusted cost of their wares without putting off shoppers. A 5.5% jump in the cost of a pint after years of 5% increases does not send beer drinkers searching for other pubs in the way that a 0.5% hike after years of no change might. Thus falling inflation can make prices “stickier”. To compensate, firms instead find other ways to impose costs on buyers—such as making products smaller or lower-quality.

Labour markets are affected, too. In a world of low inflation, the ability to trim pay by raising wages less than inflation is lost to firms, with serious macroeconomic consequences. Economists blame sticky wages for causing unemployment during recessions. Facing reduced demand, firms that cannot cut pay to maintain margins while slashing prices instead reduce output—and sack workers.

But nimble firms have other options: the employment version of shaving a bit of chocolate from the bar. Some cut costs by boosting output per worker, often by driving workers harder. Tellingly, growth in output per worker now tends to fall in booms and rise during busts, precisely the opposite of the pattern 40 years ago, when inflation was high. Firms can respond to market pressures by reducing the benefits available to workers. Or they can offer workers more tortuous schedules. Research published in 2017 suggests that being able to vary workers’ hours from week to week is worth at least 20% of their wages.

If it happens on a sufficiently large scale, the practice of tweaking quality in lieu of price could play havoc with essential economic data. Statistical agencies do their best to account for changing product quality, but if adjustments are unexpectedly common or subtle then muted inflation figures could easily be concealing a more turbulent economic picture. Central banks watching for big swings in inflation or wage growth as a sign of trouble could be reacting to figures that bear far less relation to business conditions than they used to.

What’s more, the substitution of quality for price as firms’ main way of responding to changing market conditions weakens the case for keeping inflation low and stable. Inflation makes relative prices less informative, economists reckon, making it harder to decide what to buy and how to spend. Rather than clarity, low inflation has brought a different sort of confusion: one of shrinking chocolate bars and lost holidays.

Comments

  • Quite. And along with all of that, we get the fake-out games from manufacturers and food producers: the same size box, but the net weight (Triscuits? Wheat Thins?) is less. Or the pricing games: Want to buy a bunch of frozen burritos? Then you find it priced per pound, rather than per piece????? Not helpful. Deliberate deception. No one eats burritos by the pound. And on and on. Ethics in business? Dream on.
  • edited August 2019
    @Crash: Yeah, the food inflation fake-outs are rampant these days, for sure. Notice how what we used to think of, buy, and consider a "pound of coffee" has become 12oz?

    I'll add one grumbling observation: I love how there's CPI and 'Core CPI' -- the latter excludes food and energy. Tell me one person who doesn't need to use those things ... and those two items are the items most likely to affect one's spending on a personal, daily, and regular basis.


  • Bear in mind that a number of important government programs such as Social Security or government debt are indexed to inflation, so there is an incentive to understate what inflation really is.
  • @LewisBraham- I hope that you're not suggesting that our government would attempt to distort reality. Why, that would amount to an attempt to be less than truthful to the citizens of this great country!

    (If we're not really great again yet, we're surely on the way.)
  • edited August 2019
    I'm shocked, shocked....:-)
  • Given the rampant obesity in the US, smaller food portions might be a good thing!
  • 12 oz. bottle of beer, not at the local brewery ! Bottles register11.16 fl oz !! Usually can fine a good bargain to offset the .84 oz loss.
    Derf
  • @Derf: the bottles you mention (such as at Aldi) are 33cl, the most common beer bottle size in countries using the metric system. Back in the day, my friends and I were most impressed by the NE beer, Narragansett, that came in "Imperial Quarts" of 40 oz.
    @Tarwheel: right on! I didn't hear a single Dem candidate at the Iowa State Fair mention the consequences of eating the local specialties. Then again, no candidate in this country would dare to suggest that prevention of obesity would go a long way to dealing with the healthcare crisis.
  • On the flip side, years ago we went from half gallon (64 oz) containers to 2 liter (67.6 oz) bottles. Sometimes a liter is just a liter.

    Now if I just knew how many cubic inches my 2.0L engine displaced, I'd be all set:-)
    https://www.cjponyparts.com/resources/engine-size-chart
  • @BenWp What do you think would happen to the U.S. economy and the stock market if Americans stopped overconsuming? I think there is a 1 to 1 correlation between each inch on the average waistline and each 100 point gain or loss in the S&P 500.
  • @LewisBraham: much like climate change denial, your argument (and I realize you're being ironic) that our economy could not stand the disruption begs the question. We are eating ourselves into oblivion while rationalizing that to eat sensibly would cost the jobs of the all-you-can-eat buffets, the meat and dairy industries, the snack purveyors, and so forth. I'm only one soul on this planet, but the path I'm taking is eat no animal products, raise my own veggies, exercise daily, and gently promote my values to others.
    As I've said before, Voltaire's "Mais il faut cultiver notre jardin" is my motto. As nicely as possible, I try to suggest that if one abstains from hamburger for one day a week, one can make a meaningful contribution to reducing obesity and global warming at the same time. Do I over consume? Of course, but I'm on the path of progress, not perfection.
  • "the path of progress, not perfection"

    Well said. I like that a lot.
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