Why do we want to know the inflation rate? It’s because everyone is uncomfortable in an epistemic void. We want to know what is happening to us, is it getting worse, or if the problem is abating. In order to fill that void, we need a number. To get a number, we need something called science and we must apply it to real-world conditions.
The science presumes that something is knowable, while applied science presumes that it is discoverable. It was this way during the pandemic. Back then, I had no particular reason to doubt the ability of the experts to track and even perhaps control infectious disease. We learned, however, that the charts and graphs, the spreadsheets and models, were entirely contingent on testing. Testing was neither universal nor truly accurate.
We also found that there are gradients even in testing that complicate the picture. An exposure is not the same as an infection, and an infection is not the same as a case, and a case is not the same as a medically significant case, much less a death. Even death became murky: is the presence of a pathogen necessarily the cause?
The more we looked at the practical application of “the science” to fill our epistemic void, the murkier matters became. We further learned that all these ambiguities can well serve powerful interests because they can be manipulated to fit a narrative.
At some point, we surely all wondered if there was much point to the pretensions of science at all. We presume to know so much and we surely know more than we used to know. But what if we only know a tiny fraction of what we do need to know in order to satisfy our urges? And is it even possible to know how much we do not know?
All these problems that presented themselves in the pandemic have also presented themselves during the great inflation.
We know it is real. We can tell from our bills. It has inspired our spending habits to change. We no longer go out to dinner on a whim. We are more careful about vacations and even lights in the house. We no longer just shop for what we want but what we think we can afford. With real household income on the decline, we’ve all changed.
But now of course we want a number on that. Isn’t that what we pay the experts to do? The experts say that grocery prices have increased 20 percent over two years. For any real shopper that is something of a joke. Most people would say prices are up 50 percent or even 100 percent. And maybe that is an exaggeration based on personal trauma. But what is the real number? Here is where matters are confusing.
Let me give some examples based on my own archive that I’ve been digging through.
I found that three years ago, I bought a gift box of baklava for my mother that was $17. I am considering reordering that now. The new price is $18. That is not a huge increase. It is entirely tolerable.
Why might that be the case? My own theory is that this is a fancy gift, and already very much overpriced relative to the underlying value. I bought it because it was fancy. The profit margins were already built in, and probably the company selling that was fully prepared to absorb increased costs and not pass them onto consumers for fear of lowering demand for their luxury product.
On the other hand, I found two years ago I had ordered olive oil for $14. It is now $27. That’s a 92 percent increase in price. That’s enormous and shocking. Why might that be? Again, I’m guessing but this is a mass market good with huge costs associated with transportation and processing. Plus there is a great deal of competition for brands and hence profit margins might already have been low.
When the company selling the oil is considering what to do with the hot potato of higher costs, it must consider elasticities of demand for the product. If elasticities are high, it means that consumers are price-sensitive. A higher price will cause demand to crash. A low elasticity of demand means that prices can move up dramatically and not change demand that much.
I’m guessing that the elasticity of demand for olive oil is relatively low because it is a specialized product with obvious substitutes that existing buyers will not consider. If you love olive oil, you are going to get it regardless, not to mention the fact that people who buy olive oil in the first place would likely be the high-end and cash-rich buyers to begin with, and their elasticities of demand would tend to be lower anyway simply because they have more to spend.
As a result, the price of olive oil has gone way up because the companies selling the product are low-margin companies (due to high competition) selling to a high-end clientele with a low elasticity of demand. Therefore the price goes up dramatically.
A price index would combine olive oil and gift-box baklava into a single trend, and split the difference based on the number included in this basket of goods. That works for two products but what about a trillion goods and services? And how are we going to weigh these things within the index and their importance? Whatever we do, we have to keep it the same from one one period to the next. Ideally we would do this over many decades so that we have some basis to compare.
That’s the theory in any case but there are complications. In the 1980s, we saw the price of computer memory crash but the price of hardware more or less stayed the same. As a result, many economists said this doesn’t make sense. If you spend $1,000 on a machine with x memory and $1,000 on a machine 5 years later x+1,000 memory, doesn’t it make sense to adjust the index based on what you are obtaining?
Thus was born the “hedonic” adjustment. Prices came to be theoretically lowered based on the quality of the good you were obtaining. This fashion for hedonic adjustments invaded the whole space of indexing theory and practice and suddenly everything changed. Economists were now in charge of deciding precisely what was obtained for the money spent, and they went wild with it.
Hedonic adjustments were made in every good. This is a major reason why inflation was so low during the 2000s and following.
But hedonism cuts both ways. What if the quality of the good or service you obtain is declining in quality? Is a hedonic adjustment now necessary in the other direction? One might think so but I’m unaware of any good or service these days that has been subjected to this.
For example, if you used to get your sheets changed daily at the hotel and now you do not, do economists now say that the same rate at the hotel is actually higher? No way. The hedonic adjusters have taken a pass on calling higher prices on lower quality. Indeed, they are nowhere to be seen.
There are myriad other problems. The indexing strategies presume that the price is all about the product you are buying but is that even true? Let me provide an example. Two days ago. I was at a restaurant above a glorious flowing stream, surrounded by grass, with an absolutely gorgeous setting and attentive servers.
I ordered a beer. It came in a 10-ounce glass. It was $7, an outrageous price that would have shocked everyone two years ago.
But was the tiny beer actually $7? Or was I actually buying the experience? I will tell you this: it was worth it for me. But would you think that the beer should be indexed or the whole experience surrounding the beer be indexed? I don’t have the answer. And this is precisely the problem.
Price indexes presume that we are buying the thing priced but maybe we are buying everything else associated with the shopping experience itself. You can buy rice at the Dollar Tree for a tenth of what you pay at another store. Is what is being priced the rice or the venue?
Here’s another example. These days people are shifting from expensive places to shop toward cheaper places: Whole Foods to Aldi, Bloomingdale’s to Goodwill, Restoration Hardware to Facebook Marketplace. Let’s say that these people end up with exactly the same good. Are you going to consider inflation or deflation?
Truly I do not think there is an answer there. These are responses to inflation and certainly not the measure of either inflation of deflation.
If we have learned nothing else from our times it is that inflation affects different people and different sectors in different ways, and they probably are not comparable. We think that a claim of 20 percent is implausible—perhaps it has been 35 or 50 percent or more over three years—but cannot agree on precisely what the right number should be. I hate to suggest this but that might be the correct truth: there is not one inflation rate but trillions. Further, this is probably incalculable.
Perhaps the best answer to the epistemic void is the most difficult one of all. We have to learn to live with what is unknown and truly unknowable. We know there was a virus and we know there is inflation. We know they are bad. Beyond that, we might have to be content with what we do not and cannot know.
