Why people think inflation is high, despite headline inflation being the lowest since the mid-1950s

Many people tell me that the “average people” they talk to simply don’t believe inflation rates have been low over the past 4 years, despite the headline CPI rising at roughly a 1.2% rate since July 2008.  There are three reasons for this cognitive fallacy:

1.  Confusing rates and levels.

2.  Confusing ‘cost of living’ and ‘standard of living.’

3.  Assuming the term ‘inflation’ refers only to the rise in the price of things they don’t want to see get more expensive.

A poll around 1990 showed that most people thought inflation was higher than it had been 10 years earlier.  Of course inflation was far lower (5% vs. 13%).  But when people hear the term ‘inflation’ they think in terms of cost of living, or price level.  Not 1 person in 5 knows what a derivative is.  And the cost of living in 1990 was higher than in 1980.  And each month the cost of living in America hits a new record, even as inflation plunges to very low levels.

If you are a teacher, ask your class the following:  ”Suppose the price of all goods rose by 10%, and at the same time everyone’s income also rose by 10%.  Would the cost of living have actually increased?”  Ninety-five percent of students will get it wrong, even at Harvard.  Of course the cost of living goes up 10%.  But there is no change in the standard of living, which is what confuses the students.  People feel that real incomes have done poorly in recent years; nominal incomes aren’t keeping up with inflation.  And they are right!  But ‘inflation’ is the wrong term for that problem, it’s falling real GDP caused by low AD.  Go to Japan and ask people how they’ve enjoyed the steadily falling cost of living since 1995, and I’ll bet you get a lot of blank states (mostly because the Japanese don’t speak English.)

Imagine a newly minted college grad who moves to Florida or Arizona and starts working in a medical supply company.   She goes out to buy a house, and finds that the price has been slashed in half since 2006, from $280,000 to $140,000.  Then she goes to the bank and finds the lowest mortgage rates in history.  The monthly payments will be laughably small.  Next time someone tells you that inflation is higher than the CPI, because they pay more for groceries, point out that inflation might be overstated because house prices have fallen by 35%.  Then watch the look in their faces as they process the information.  ”But aren’t falling house prices bad . . .”

PS.  I do realize there are alternative (rental equivalent) ways of looking at the housing cost issue, but I still think my example is valid, at least to some extent.  There is enormous “market segmentation” between owner-occupied and rental housing.


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55 Responses to “Why people think inflation is high, despite headline inflation being the lowest since the mid-1950s”

  1. Gravatar of ThomasL ThomasL
    4. October 2012 at 07:28

    Housing prices are still well above the pre-bubble levels most places.

  2. Gravatar of Major_Freedom Major_Freedom
    4. October 2012 at 07:37

    Speaking of cognitive fallacies, if many people say they are experiencing inflation, but the “headline CPI” stats do not gel with those judgments, then maybe the problem is the statistic itself, not people’s judgments of inflation.

    It is telling that you would put so much faith in a statistic that the government has every incentive to under-report. Only a fool would blindly believe a judge who is his own defendant.

  3. Gravatar of Doug M Doug M
    4. October 2012 at 07:39

    House prices are not part of CPI — but rent is! You will get fewer distressed responses if you say rent.

    There were several articles in 2009 — 2011 about the lack of a cost of living adjustment for social security recipients. Nearly all of the news headlines referred to this as a benefit cut.

    Many people use gasoline prices as a proxy for inflation. It isn’t a good proxy but it is one price that people know and most people pay. It is easy to talk about how much more it costs to fill your tank.

    Furthermore food and energy is frequently dropped from CPI calculations for some uses. However, there are some out there who think it is never part of the calculation.

  4. Gravatar of johnleemk johnleemk
    4. October 2012 at 07:46

    Major_Freedom,

    Speaking of cognitive fallacies, if many people say breaking windows creates prosperity, but the “GDP” stats do not gel with those judgments, then maybe the problem is the statistic itself, not people’s judgments of broken windows.

    It is telling that you would put so much faith in a statistic that the government has every incentive to over-report. Only a fool would blindly believe a judge who is his own defendant.

  5. Gravatar of John Thacker John Thacker
    4. October 2012 at 07:48

    MF:

    Perhaps in some cases, but the example of the 1990 poll is pretty strong evidence that at the very least people are biased to overestimate inflation. Or will MF defend the idea that inflation was higher in 1990 than in 1980?

    A bigger problem is that lots of people are long housing, and went into debt to purchase it. You can hardly expect them to cheer falling housing prices. Most of them, in my experience, will if you ask agree that lower prices are good for home buyers, and will also admit that when their own house values go up it makes it tough to buy a house. But, they still do think about their own interests; if they have kids, they might think about their kids having to buy a place, though.

    Perhaps people that are likely to move should rent more often.

  6. Gravatar of John Thacker John Thacker
    4. October 2012 at 07:50

    For people who already have a mortgage, telling them that inflation is down because home prices have dropped is like telling someone who’s been invested in their 401(k) that it’s “great news that stocks are so cheap right now.”

    “It’s never been a better time to buy!” does get used in both markets.

  7. Gravatar of foosion foosion
    4. October 2012 at 08:16

    There are many behavioral issues relating to inflation, including:

    People pay more attention to big changes in things they deal with frequently, even if a small part of their budget, than to small changes that can have a larger impact on total spending.

    People believe that price increases are the fault of evil inflation, while income increases are due to personal virtue and have nothing to do with inflation.

  8. Gravatar of Adam Adam
    4. October 2012 at 08:17

    Yeah, Major Freedom, if there’s only thing that we know about people, it is that they are nature’s perfect little calculators and completely immune to biases and cognitive fallacies.

  9. Gravatar of Saturos Saturos
    4. October 2012 at 08:18

    Scott, you simply must do a reply to this new piece at the FT, by Gavyn Davies, on Woodford and NGDP targeting:
    http://blogs.ft.com/gavyndavies/2012/10/03/professor-woodford-and-the-fed/

    where he links to this paper: http://www.fulcrumasset.com/files/Fulcrum%20Research%20Paper%20-%20Professor%20Woodford%20and%20the%20Fed.pdf

    and rips off the market monetarist diagrams, changing them slightly by not doing them on a log scale.

  10. Gravatar of Adam Adam
    4. October 2012 at 08:22

    Thanks, although I think there are a few other things going on.

    Namely, I think there is a ton of muddled thinking, particularly in the financial press, that just assumes there must be inflation because of increases in the money supply. Some of which is motivated thinking resulting from fear of Fed policy that might undermine the value of the fixed income portfolios.

    And all of that is backstopped by the usual crazies, thus reinforcing the idea.

    Then again, maybe anyone reading that all that stuff isn’t “average.”

  11. Gravatar of Gene Callahan Gene Callahan
    4. October 2012 at 08:28

    John, John, and Adam: Have you all got a license to feed that there troll? Cause if not, I’m'a have to report you to the park ranger.

  12. Gravatar of Major_Freedom Major_Freedom
    4. October 2012 at 08:36

    johnleemk:

    Speaking of cognitive fallacies, if many people say breaking windows creates prosperity, but the “GDP” stats do not gel with those judgments, then maybe the problem is the statistic itself, not people’s judgments of broken windows.

    Fully agreed. I agree that GDP does not tell us true economic health.

    It is telling that you would put so much faith in a statistic that the government has every incentive to over-report. Only a fool would blindly believe a judge who is his own defendant.

    I don’t get it. Are you trying to be sarcastic, and in the process, inadvertently agreeing with me, or do you actually think you are presenting a knock down argument against mine? Everything you wrote I agree with, which to be honest, is very rare on this blog, and so please understand when I approach your post with some skepticism.

    John Thacker:

    Perhaps in some cases, but the example of the 1990 poll is pretty strong evidence that at the very least people are biased to overestimate inflation.

    The 1990 poll still relied on CPI.

    Or will MF defend the idea that inflation was higher in 1990 than in 1980?

    You do know that the “official” methodology of calculating inflation rates drastically changed during this time, right?

    A bigger problem is that lots of people are long housing, and went into debt to purchase it. You can hardly expect them to cheer falling housing prices.

    You can hardly expect more prudent individuals to pay the costs of their errors via inflation just because the state screwed up in generating a housing bubble. If you ask me, Greenspan, Bernanke, every Fed economist on the payroll who championed artificially low interest rates, Congress who passed laws that boosted housing, all of these people should PERSONALLY pay for the costs that naive families incurred. But we both know the chances of that are next to nil. I mean we can’t even get war criminals to pay a fine. So let’s use the printing press and externalize the costs on everyone, so that the costs can hopefully be imperceptible to each individual. Then, attack them should any dare make a mistake about inflation rates, so that we use that as leverage for the next time there is inflation.

    Most of them, in my experience, will if you ask agree that lower prices are good for home buyers, and will also admit that when their own house values go up it makes it tough to buy a house. But, they still do think about their own interests; if they have kids, they might think about their kids having to buy a place, though.

    Frankly, if you bought into the housing bubble (I didn’t), and you wanted to make a profit by reselling it, then at the end of the day, you can’t expect any losses to be covered by “society”, meaning others who had nothing to do with their decisions. Seriously, at what point does self-responsibility come into the picture? Seems like all I see are apologies and desperate pleas that just so conveniently happen to imply more inflation as the solution.

    Perhaps people that are likely to move should rent more often.

    Perhaps economists should be teaching ABCT in more departments around the country, so that the average person can glean a better picture of the economy when the Fed makes announcements of lowering the key interest rate via inflation of reserves, which makes bubbles more likely. That way, the chances of them being the greater fool is reduced.

    I don’t get it. I didn’t buy a house hoping that the price trend will continue. I bought my house knowing that it could collapse in price. I took that risk. Why do I have to pay for the costs of those who made bad decisions via depreciation of my income and cash balance, due to the fact that I am far down the line from the printing press?

    Adam:

    Yeah, Major Freedom, if there’s only thing that we know about people, it is that they are nature’s perfect little calculators and completely immune to biases and cognitive fallacies.

    That is not my position at all. I fully accept that policy makers, regulators, Fed officials and economists have biases and cognitive fallacies. I also fully accept that you, because you’re human also, have biases and cognitive fallacies, which makes your argument to me about biases and cognitive fallacies, a likely biased and cognitively fallacious argument.

    Or are you immune from the biases and cognitive fallacies you mentioned to me? If you’re not, how do I know whether or not your argument to me here is not biased or based on cognitively fallacious premises?

  13. Gravatar of Major_Freedom Major_Freedom
    4. October 2012 at 08:37

    Gene Callahan:

    John, John, and Adam: Have you all got a license to feed that there troll? Cause if not, I’m’a have to report you to the park ranger.

    My my, you are a sensitive bird.

    A troll is not what you think it is.

  14. Gravatar of RPLong RPLong
    4. October 2012 at 09:16

    How long do you suppose food price inflation can out-pace every other kind of inflation before standards of living start to decrease?

  15. Gravatar of Prakash Prakash
    4. October 2012 at 09:16

    johnleemk,

    Your comeback to MF does not make sense to me. If windows get broken and they are repaired, GDP rises. The statistic that shows the true picture is the aggregate networth of the citizens of the nation.

  16. Gravatar of ssumner ssumner
    4. October 2012 at 09:26

    Saturos, I responded to that in a previous comment section.

    RPLong, A trillion years.

  17. Gravatar of Major_Freedom Major_Freedom
    4. October 2012 at 10:02

    Prakash:

    Your comeback to MF does not make sense to me. If windows get broken and they are repaired, GDP rises. The statistic that shows the true picture is the aggregate networth of the citizens of the nation.

    I think what happened is either that johnleemk hastily presumed that I hold GDP to be a statistic that really does accurately measure economic health or well-being, in which case his comment is exposing my previous comment to be flawed, or it wasn’t a “comeback” at all but rather an addition that uses the same or similar reasoning.

  18. Gravatar of Kevin Dick Kevin Dick
    4. October 2012 at 10:25

    Scott, I think the situation is actually _worse_ than you think with regard to asking the average person about inflation. He is not confusing rates and levels. He is not doing any calculation at all.

    A la Kahneman and Tversky, when you ask someone a hard question, the first thing his brain tries to do is substitute an easier question. (_Thinking Fast and Slow_ has a wonderful chapter on this.) So the average person’s brain does this… Inflation = bad for economy. Economy now is bad. Therefore, high inflation.

  19. Gravatar of Saturos Saturos
    4. October 2012 at 10:37

    “Saturos, I responded to that in a previous comment section.”

    Aargh, which one? Comments should be searchable too!

  20. Gravatar of Gabe Gabe
    4. October 2012 at 11:05

    Education costs, medical costs, food and energy cost have gone up rather quickly the past 10 years. Much quicker than the CPI.

    I understand that you could find quite a few categories(about half) that have gone up slower than the CPI.

    However, there are individuals who have expenses that fall more heavily in the 4 groups I mentioned. Those people may also have wages that have been stagnant if they are anything liek the median worker. So that significant chunk of the population is going to give answers to inflation questions that QE infinity proponents don’t like…sorry that the actual population is not as homogenuos as your models, it must be a hard life thinking that civilization is made better by more money printing.

    I also am not sure what Johnleemk was trying to do there.

  21. Gravatar of Doug M Doug M
    4. October 2012 at 11:09

    Prakash,

    Repair of a broken window does represent a contribution to GDP but it is not an increase in “aggregate networth of the citizens of the nation.” It is a diversion of productive resources to get total weath back to even.

    You cannot break windows to make society wealthier.

    And, GDP is an imperfect measure.

  22. Gravatar of Major_Freedom Major_Freedom
    4. October 2012 at 11:13

    Gabe:

    Those people in the 4 groups you mentioned have to suck it. They’re collateral damage in the holy crusade of inflationism, which is not meant to benefit the individual, but to benefit the state, the banks and politically connected and other special interest groups. As long as aggregate spending rises by X%, then monetarists have halos over their heads and all problems are the work of liberals and stupid people who refuse to contract for higher wages in the face of less than 3% rise in sales revenues.

    I really wish inflation took the form of the central bank writing checks for everyone equally, so that incomes and prices rise together, but alas, we live in a hegemonic society of preferential rights and privileges, so don’t blame me as I try to gain from it somehow. The peons can eat my dust.

  23. Gravatar of Gabe Gabe
    4. October 2012 at 11:18

    There has also been some serious inflation in mortgage backed securities over the last 4 years.

    I wonder who that has helped?

  24. Gravatar of Doug M Doug M
    4. October 2012 at 11:18

    Kevin Dick,

    I think the behavioral aspect of an assement of inflation is even simpler. If you ask someone if inflation is high or low, they will anchor on goods whos are prices up,(gas, beer, a college education), and will not think about the things that are actually cheaper (electronics). Nor will they be aware of the “hedonic adjustment.” i.e. your new phone does things that your old phone didn’t for the same price.

  25. Gravatar of Doug M Doug M
    4. October 2012 at 11:22

    Gabe,

    Securties prices are not part of inflation. However, rising MBS prices is falling MBS rates.

    So, who has been helped. People who actually have home equity and are able to refi to a 3.25% morgage, new home buyers, mortage brokers and banks.

  26. Gravatar of Gabe Gabe
    4. October 2012 at 12:44

    Writing checks would have helped home buyers;lletting house prices fall would have helped home buyers.

    You know good and god damned well that purchasing MBs was merely welfare for the rich primary dealers

  27. Gravatar of Mike T Mike T
    4. October 2012 at 12:45

    “However, rising MBS prices is falling MBS rates.”
    >> Rising prices and falling rates from artificially created demand by a central bank’s open-ended assault on the market pricing mechanism. Do you think this will help homebuyers who bid up prices artificially high once again on homes while getting stuck with the debt as mortgage brokers/bankers, home builders/sellers, Wall St, etc benefit? And forget about just the price inflation, but how about the dangerous distortions in perceptions of risk? How do we know the 30yr mortgage rate should be that low? Prices are supposed to convey information and the only information being conveyed is somebody in an ivory tower in DC who wants a bunch of people to take on more debt to bid up housing prices.

    I thought when Bob Murphy exposed Ezra Klein’s Uncle Ben’s Crazy Housing Sale proposal for the dangerous idea that it was would be the end of this. And here goes Uncle Ben essentially doing just that.

  28. Gravatar of Gabe Gabe
    4. October 2012 at 12:47

    Yes your new phone allows drone attacks tp be guided within 2 feet of you! Hedonically adjust that

  29. Gravatar of Bababooey Bababooey
    4. October 2012 at 13:53

    Ask the average person about inflation and they will say whatever permits them to politely and expeditiously leave your company. And you shouldn’t denigrate people for that, they– we– all have one life to live as fulsomely as we see fit. Very few interpret the blessing of life as requiring that they memorize government statistics in case an economist inquisitor shows up.

    Even if an amateur diligently examines the debates among economists concerning inflation, the diagnosis of the Great Depression & Recession, and so on, they would, like I have, found obstinate disputes and accusations (see, e.g. this comment section). So, if you come chastising me for not knowing historical rates of CPI, this dutiful amateur might ask you, What have the economists ever done for us?

    (I wouldn’t actually be so churlish, because economists like Professors Sumner, Tabarrok, Selgin, Rodrik et al have charitably shared their knowledge, entertained silly questions and, more or less, graciously provided forums for disputants. That’s something and I’m thankful for it.)

  30. Gravatar of ThomasL ThomasL
    4. October 2012 at 14:27

    “Yes your new phone allows drone attacks to be guided within 2 feet of you!”

    Gabe FTW

  31. Gravatar of Matt Waters Matt Waters
    4. October 2012 at 15:00

    In my experience, the big issue is no knowledge of the link between inflation and demand. I only saw a little bit of the debate last night, but I absolutely cringed when Romney said “gas prices have doubled under Obama.” Gas prices went down in 2008 because unemployment doubled and demand declined significantly. Romney is apparently promising to bring unemployment back to 10% so we can have $2 gas again.

    But then again, gas prices are Exhibit A for economic fallacies 90% of Americans have. I tell people that anti-gouging laws cause the shortages and lines in disaster areas, and they look at me like I’ve grown three heads.

  32. Gravatar of Matt Waters Matt Waters
    4. October 2012 at 15:24

    “Education costs, medical costs, food and energy cost have gone up rather quickly the past 10 years. Much quicker than the CPI.”

    Good luck trying to adjust for quality with education and medical costs. Both sectors suffer from customers who do not take price into consideration. At my university, for example, a student in 2012 would have a far nicer campus than a student in 1990 and the professor salaries have likely gone up as well. Since all university presidents have their main goal as staying up in the rankings, all university presidents decide to increase tuition to put more money into their college and attract higher quality students.

    A similar thing is going on with hospitals where patients are also insulated with costs. Hospital CEO’s, even for non-profits, see their main goal as attracting more insured patients and getting a better bargaining position with insurers. Cost is just not a factor. Although that is just one of the numerous issues driving up health care costs. Many of these issues, such as new hospital wings and new treatments, increase quality and are not just supply-side inefficiencies.

    As far as energy and food, they have gone up generally where the commodities have international markets. Oil has gone up while natural gas, which cannot be easily transported, has gone down considerably in the US.

    Higher oil prices are a consequence of worldwide production shifting to more manufactured products. Human labor has produced more and more stuff due to higher productivity in places like China, while commodities like oil have geological constraints. That means worldwide consumption will shift from less commodities and more manufactured goods and services to find the point of highest utility. The changing mix is why headline CPI has been higher than core in the 00′s. In the 70′s, headline and core tracked each other since the consumption mix did not change. Demand went up for everything.

    All that is of course much beyond the average person on the street.

  33. Gravatar of gabe gabe
    4. October 2012 at 17:12

    I can see how you would think NG prices have gone down, given the Marcellus shale growth and the bear market over the last 4 years…

    but if you look at the actual prices Jan 1, 2000 the Feb contract was $2.17/mmbtu

    12 years later…. isthe February Henry Hub contract$3.84/mmbtu

    4.8% compound annual growth in prices.

    Even the commodity in North America that has had one of the biggest bear markets ever.

    I’m no PHD in economics but…I’d say your just kinda pulling inflation estimates out of your ass kind alike the average person on the street.

  34. Gravatar of Saturos Saturos
    4. October 2012 at 18:01

    Matt, obviously you shouldn’t be adjusting for quality with costs, but with benefits. So it’s inherently dubious what the value of govt output is.

    ditto to ThomasL

  35. Gravatar of Benny Lava Benny Lava
    4. October 2012 at 18:14

    Scott,

    I have long said that people are confusing inflation with purchasing power. And for a lot of people purchasing power declined.

    Also did you not ban the word inflation? Or has it been rescinded and I missed it?

    Also I partially agree with Yglesias when he talks about inflation asymmetry and how some people are experiencing much more inflation than others.

  36. Gravatar of Jim Crow Jim Crow
    4. October 2012 at 18:15

    One additional point about inflation I’d make is that even if the statistical data behind it is perfect, you can still miss out on some pretty relevant information. If a computer in year 1 retails for $1000 but in year two it retails for $1100 but is twice as powerful, I’m sure most people, even the few numerate ones, would intuit that as inflation even though, from a cost per computation standpoint, it’s actually not.

  37. Gravatar of Matt Waters Matt Waters
    4. October 2012 at 20:47

    Saturos,

    That is the issue. It’s not all quality improvements, but it’s not all inflation either. I honestly have no idea how to account for it.

    What I do know is that most sectors have not seen anything like the inflation of the 70′s. If that were the case, then rent and cars and other things would see sustained increased. Since wages are most of the cost for non-commodities, that would mean high wage inflation as well. We’re just not seeing that.

  38. Gravatar of Why people think inflation is high, despite headline inflation being the lowest since the mid-1950s « Economics Info Why people think inflation is high, despite headline inflation being the lowest since the mid-1950s « Economics Info
    4. October 2012 at 22:01

    [...] Source [...]

  39. Gravatar of Dirk Dirk
    4. October 2012 at 22:48

    Hey Scott, I’ve been a fan for, well, as long as possible. But I’m not an economist and often my comments are too laymanesque to warrant comment. Nevertheless, I’m a believer that there’s value in attempting to teach us laymen.

    I suggested this idea to Ryan Avent, but he seems to have balked. I believe that a post on the 70′s regarding supply shocks, the Phillips Curve, and stagflation could be extremely edifying.

    Even though to smart people like you, there is no connection between the situation today and the 70′s, to a lot of dumb people like me, we want to understand for sure why stagflation won’t happen if the Fed is too loose tomorrow.

    In all seriousness, many commentators (not the most informed, maybe) have tried to compare today’s situation to the 70′s. I think there would be much value in your explicating the stagflation of the 70′s vs. what we are in today. Maybe that’s not academic enough for you, but I sure wish you could give me some ammo to point my non-academic anti-inflationist friends to.

    Thanks.

  40. Gravatar of Ed Dolan Ed Dolan
    5. October 2012 at 00:30

    I think “loss aversion” provides one of the strongest behavioral bases for the upward bias of perceived inflation. Behavioral economists like Daniel Kahneman report that people suffer roughly double the perceived subjective pain from a given dollar loss compared with the perceived subjective satisfaction they get from an equal dollar gain. People perceive the impact of price increases on their living standards as losses and the impact of price decreases as gains. As a result, their perceived inflation rate uses different weights than the CPI, that is, they double weight price increases and single weight price decreases. See more on this idea here ( http://tiny.cc/yhaiew )along with a back-of-the-envelope attempt to calculate an index of perceived inflation.

  41. Gravatar of Major_Freedom Major_Freedom
    5. October 2012 at 04:48

    Ed Nolan:

    I think “loss aversion” provides one of the strongest behavioral bases for the upward bias of perceived inflation. Behavioral economists like Daniel Kahneman report that people suffer roughly double the perceived subjective pain from a given dollar loss compared with the perceived subjective satisfaction they get from an equal dollar gain.

    While I get Kahneman and Tversky’s general idea, their explication I think suffers from introducing cardinal quantifiers. For what does it really mean that a person should feel twice the pain from a dollar loss as they would feel satisfaction from a dollar gain? It is incoherent to me. It makes sense if we’re talking about physical processes that take on distinct values in some space, such as points on a 2D Cartesian grid. Here, I can picture a point at (1,1) and at (-1,-2). I cannot picture cardinal points for happiness and sadness. I can know what makes me relatively more happy and relatively more sad, but I don’t know what it means to be 2.356238 times happier.

  42. Gravatar of LVM LVM
    5. October 2012 at 04:58

    Inflation is there, but The Fed has been successful for the most part at keeping out of the economy by barely opening the drain(i.e. paying interest on reserves). I think there’s a lot going on in the economy which leads to the perception that there’s inflation. A couple of examples have been mentioned here:

    1 College Education: Loss of tax revenues have caused the States to shift more costs onto the student.
    2 Food prices: Gov’t mandates, fluctuations in energy prices, droughts/crop failures.
    3 The Fed: The perception of inflation bid up commodity prices (Oil, Gold, etc) over the past 4 years.
    4 Geopolitical instability in the Middle East: Bid up oil prices.
    5 Cost of Medical Care: Demographic shifts are the number one reason why costs have increased.

  43. Gravatar of Major_Freedom Major_Freedom
    5. October 2012 at 05:48

    LVM:

    One of the greatest challenges concerning perceptions of inflation is separating local supply and demand changes that lead to increased prices, from money supply changes that lead to increased prices. This is not only because it requires estimations, which require assumptions, but more importantly, IMO, it requires an understanding that inflation of the money supply does not affect all goods and services equally.

    So many, SO MANY economists, pundits, journalists and political strategists, and thus the general population, when they think of inflation, they think that inflation of the money supply raises the prices of everything equally, such that if we perceive some goods, like education, healthcare, and so on, rise in price faster than an “index”, then we are supposed to believe that local supply and demand changes are responsible, when in fact, it is possible, if not likely, that inflation of the money supply just so happened to be concentrated in those areas and did not get “released” elsewhere in an equal fashion.

    This is why I recommend we view inflation as a micro-economic phenomena, rather than a macro-economic phenomena. Yes, inflation of the money supply does raise the prices of most if not all things over time, but this is a subsidiary effect that follows localized incomes and prices rising before all others, so that at any given time, inflation actually takes the form of changed relative spending and relative prices.

    For example, $100 billion of new money created by the Fed or banking system may go to bidding up the demand for education, which then raises the price of tuition by say 5%. Most economists, when asked about how inflation could be related, will almost always look at the general price level, or some index, and observe, say, a 1 or 2% inflation rate, and then conclude “Well, since the index is only 1 or 2%, the rise in the price of education must be due to a localized supply and demand change.” And then they will probably go and rationalize it with statements like “more and more people want an education, so that’s why the price is rising faster than the general index.”

    I would have thought that after the Lucas Critique, mainstream economists would have ceased using aggregates altogether, and focused solely on micro-economic phenomena, which can FULLY explain the effects and implications of inflation of the money supply, but alas, we are still witnessing intellectual laziness, corrupt philosophical conceptions of the ideal, and thus a desire for singular variables that explain everything. It is very much like ancient “The One God” religions of the past (which continue to this day), but in the form of economic concepts. So instead of relative demands, relative prices, relative spending, we instead have aggregate demand, aggregate price levels, and aggregate spending. These singular variables are unfortunately treated as the basis for, rather than manifestations of, micro-level phenomena.

    Unless and until the Fed sends checks to every last US dollar account holder, such that inflation of the money supply really does have primarily aggregate effects, if the Fed continues to send checks to only a few select and privileged parties in a localized fashion, then inflation MUST be understood micro-economically. If not, the economist or political strategist is simply not using the correct theoretical framework.

  44. Gravatar of ssumner ssumner
    5. October 2012 at 07:42

    Bababooey, I’m not criticizing people for not understanding inflation, why should they? After all, I’ve constantly argued inflation is meaningless.

    It would be like blaming the average person for not understnading string theory–it doesn’t impact their daily life.

    Dirk, Tell them inflation was 8% and long term interest rates were 10%, now inflation is one percent and long term interest rates are 2%. This isn’t even close to being the 1970s. It’s almost the opposite.

  45. Gravatar of Silas Barta Silas Barta
    5. October 2012 at 10:38

    @Kevin_Dick: A la Kahneman and Tversky, when you ask someone a hard question, the first thing his brain tries to do is substitute an easier question. (_Thinking Fast and Slow_ has a wonderful chapter on this.) So the average person’s brain does this… Inflation = bad for economy. Economy now is bad. Therefore, high inflation.

    Isn’t it such a great coincidence how the latest in cognitive bias research just *happens* to apply in just the right way to support your political views?

  46. Gravatar of Alexei Sadeski Alexei Sadeski
    5. October 2012 at 17:04

    Joe Sixpack considers the prices of gasoline and milk as the sole indicators of inflation.

    This fact alone should be extraordinarily strong evidence that the US has experienced no serious inflation recently.

  47. Gravatar of Chase Chase
    5. October 2012 at 18:28

    Here’s a question: Why isn’t asset appreciation considered inflation?

  48. Gravatar of JTapp JTapp
    7. October 2012 at 06:21

    When I posted a favorable link to this post, someone with a PhD suggested I go shopping (ie: his lying eyes say the BLS is wrong). An awful lot of Austrians think inflation is high is because they use the pre-Keynesian definition of inflation “inflation is an increase in the money supply.” Here’s an example from a writer for the Washington Times who supposedly taught economics for years. It’s no wonder people on the right think the BLS is lying or, at best, unhelpful. They were taught it in college.

  49. Gravatar of Suvy Suvy
    8. October 2012 at 20:52

    The problem is how do you define inflation. I’m a believer in the idea that money is not neutral and affects consumer prices differently than commodities and especially assets. Inflation is something that is very difficult to measure because of the non-neutrality of money.

  50. Gravatar of Secondary Sources: Financial Recessions, Inflation, Paternalism and Welfare – Real Time Economics – WSJ Secondary Sources: Financial Recessions, Inflation, Paternalism and Welfare - Real Time Economics - WSJ
    11. October 2012 at 23:23

    [...] –Inflation: Scott Sumner wonders why people think inflation is high. “Many people tell me that the “average people” they talk to simply don’t believe inflation rates have been low over the past 4 years, despite the headline CPI rising at roughly a 1.2% rate since July 2008. There are three reasons for this cognitive fallacy: 1. Confusing rates and levels. 2. Confusing ‘cost of living’ and ‘standard of living.’ 3. Assuming the term ‘inflation’ refers only to the rise in the price of things they don’t want to see get more expensive.” [...]

  51. Gravatar of Darin Darin
    19. November 2012 at 08:28

    First off, the confussion of inflation being a rise in prices is being made…. inflation is the increase in money supply above the increase in productivity. Typically prices rise along with inflation (or an increase in the supply of money), but this does not mean the all prices rise equally or at the same time. notice, the increase in home prices then equity prices, for example

  52. Gravatar of plasticmoney888 plasticmoney888
    19. November 2012 at 09:04

    Home price are not in the inflation statistic when there price go up so why are you mentioning them when they go down?
    The statistics are base on the monthly cost of housing which had been manipulated down by Greenspan’s artificial low rates. The statistic was base on rates so no mater how home price where getting high and risky the magician was looking at no serious inflation. Have they change that much? Your house may be worth less then your mortgage but you still are paying that mortgage and have you not notice how property tax have moved up?

    Lets forget that Gasoline and Food are not included in inflation statistics.

    If you have managed to save any money for retirement do you realty expect your Government Bonds to be paid back to in a currency that has the same value as when you bought them in? No way. At a average of 3% inflation in 20 years expect to have about 56 cents per dollar.

    Inflation is the wrong word its really devaluation. If you increase your production by 10% and we have 10% inflation you are nor even that’s fiction. What you did is compensate for inflation (devaluation)but you did not get the extra production benefit. Who got it is the question. Inflation is not a disease that Central Bank fight it’s premeditated devaluation.

    Unless you did not increase your production at all and got more devalued dollar to compensate then you would be even but what would be the point of this neutral exercise? The GDP as gone up over the years did it not?

    The obvious beneficiaries are A)The Government reducing it debt by debasing the currency and paying the lenders back in devalued currency. B)People that understand this and accumulate assets that do not depreciate as fast as the money they borrowed for it.

  53. Gravatar of Why People Think Inflation Has Soared, And That The Cost Of Bread Is Spiraling Higher | Business Insider Australia Why People Think Inflation Has Soared, And That The Cost Of Bread Is Spiraling Higher | Business Insider Australia
    5. July 2013 at 14:06

    [...] Scott Sumner made this point last autumn: [...]

  54. Gravatar of HotNewser | Why People Think Inflation Has Soared, And That The Cost Of Bread Is Spiraling Higher HotNewser | Why People Think Inflation Has Soared, And That The Cost Of Bread Is Spiraling Higher
    5. July 2013 at 14:38

    [...] Scott Sumner made this point last autumn: [...]

  55. Gravatar of Why People Think Inflation Has Soared, And That The Cost Of Bread Is Spiraling Higher Why People Think Inflation Has Soared, And That The Cost Of Bread Is Spiraling Higher
    5. July 2013 at 16:00

    [...] Scott Sumner made this point last autumn: [...]

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