Inflation Numbers and Rainbows

Tim Harford wrote a thought-provoking article on the inflation numbers calculated by governments:

“The consumer price index, or CPI, aims to measure the average price paid by UK consumers.”

 

The devil lies in the details. What basket of items you use for the calculation matters. Is it truly representative? But wait, here are further nuances: some items matter more to poor people than others (e.g. food prices).

 

And then there’s the problem that humans change their behavior. If the price of certain items goes up, they shift to cheaper alternatives. In which case, the increased price of the item doesn’t affect them anymore:

“They might pick up some cheap carbohydrates. Rice one week, spaghetti the next — whatever was on special offer.”

Even if you could magically factor in for such changing preferences, it’s not enough. After all:

“It makes sense to calculate inflation by looking at the same goods, month after month.”

But if you keep changing the list of items used for the comparisons, how can you be sure that you’re not comparing apples to oranges?

 

You might think, Ok, so the numbers are flawed, but does it really matter? The answer is Yes. Because central banks change policies based on this; governments adjust pension amounts.

 

All of which is why Harford says:

“What colour is a rainbow? On average, white… There are white rainbows everywhere, and it is not always easy to pick out the colours. But we must try.”