Perceived Inflation and the Perceived Effect of Inflation
I have my usual thoughts about inflation. People confuse levels and changes. I think this is a fundamental cognitive illusion. I think perceived inflation and the perceived effect of inflation on real incomes are based on an impressive pair of errors.
1) people estimate inflation from the price level comparing current prices to prices they remember and consider reasonable. As noted by Krugman and Nate Silver, this is not necessarily an error. It might be that they think of inflation over 24 of 36 months. The choice of 12 months is arbitrary. But it means perceived inflation is very persistent (in your Substack you just argued for monthly and consider the noise by thinking not moving averaging).
2) people think inflation causes lower real incomes because the oook at the acceleration of inflation. It is normal automatic and irreparable to assess the difference between 2 states by looking at what happens when one shifts from one to the other. This works if there is no dynamics — if lagged variables have zero effect.
Acceleration of inflation causes lower incomes as wages catch up with a lag. Similarly people believe in sleeping pills. Studies show insomnia with and without is not statistically significantly different but when one starts taking them one sleeps more and when one stops one sleeps less. The very different effect of changes and levels is due to habituation (the polite word for addiction). See also recreational drugs.
I decided to Google and Google’s artificial intelligence pulled up a perfect example.
A semantic quibble – the Google chosen instructors wrote “deflation” when the correct term is disinflation. The distinction is hugely important but not obvious to someone who conflates a decrease with a negative level. But the point is they explicitly answer the question about the effect of inflation by discussing I decided to Google and Google’s artificial intelligence pulled up a perfect example (attached). A semantic quibble – the Google chosen instructors wrote “deflation” when the correct term is disinflation. But the point is they explicitly answer the question about the effect of inflation by discussing equating I decided to Google and Google’s artificial intelligence pulled up a perfect example (attached). A semantic quibble – the Google chosen instructors wrote “deflation” when the correct term is disinflation. But the point is they explicitly answer the question about the effect of inflation by discussing “an increse in inflation” when they are trying to evaluate the effects of a higher level of inflation. The use of correlates of acceleration of inflation to evaluate the effect of higher inflation is explicit. The authors give no hint of understanding that the two concepts are different and that they are assuming no effect of lagged inflation on nominal income.
This is before the first hit (as Google has become irritating as the phrase “artificial intelligence” must appear somewhere and Google neglected the possibility of calling Google rank artificial intelligence)
Rather than explain inflation in a way to give the public some knowledge, the pundits and politicians and media commentators use whatever numbers will cause the public to respond favorably to their particular candidate or cause. If they conflate acceleration rates with absolute values or simplify to the point of absurdity it’s fine so long as they get the public to support their side. If the public is confused or misunderstands inflation (or anything else) it just makes it easier to nudge them in the desired direction with cherry-picked numbers or outright lies. The GOP said it explicitly – they love the uneducated.
Jane:
Cherry-picking appears to be the modus-operandi as opposed to the truth. It sells advertising.
Sorry but this feels off-track. Politicians and pundits are not strongly driving sentiment; the lived experience of millions is. Waldmann mentions that the timeframe that people might be operating on could be 24 or even 36 months and not the 12 of standard year-over-year measures. That’s been my view, and particularly with food prices. I look back a couple days to Dean Baker’s post here. I think it is reasonable to say he feels that people are too negative about the economy (more than just prices, but that’s an important part of it). But interestingly it felt to me that he also was saying it was fairly unimportant because behaviors seemed in line with more positive conditions. Sentiment feels like a non-problem which solves itself over the next year or so without doing anything really.
Eric
are you saying we don’t need to care about people’s fee fees?
the problem does not solve itself. people learn to deal with the new reality because they can’t do anything about it. unless, of course, they can. but they usually just end up voting for the party that best expresses their fee fees.
note that “fee fees” is the scientific term for people’s feelings, which i have learned from a prominent scientist don’t exist.
Inflation can actually be beneficial to debtors. Simple case in point with round numbers for ease of understanding:
If you have $2000 per month in income and a fixed mortgage P&I of $1000 per month, you will have $1000 left to spend on “other stuff “. After x period inflation has doubled the cost of everything and your income has only kept pace with inflation. You now have $4000 income, the same “other stuff” costs $2000 but your fixed mortgage is still $1000. You now have an extra $1000 per month (4000-(2000+1000)).
Of course this only applies to debt of a fixed term. My dad bought a house in 1970. By the mid 1980’s, he used to laugh that his mortgage payment was smaller than his car payment.
Everyone should be forced to take calculus in high school.
@Barnes,
Why?
I am not sure if Dave’s comment was a “dig” on my explanation using some simple math. Just google “inflation benefiting debtors” and you will find what I am saying to be true.
@Mark,
Having been a poor grad student in the early ’80s when inflation was in double digits, I knew your observation was correct. And as you say, simple arithmetic.
My question was directed at Barnes and the assertion that calculus should be required in HS. I took four quarters of calculus in college, and outside of those classes, never used it in my 45+ year STEM career. My daughter took two years of calculus in high school and never used it again–she’s a successful immigration attorney.
@Joel
I took a calculus book with me on the submarine and self taught (yes it could get that boring when under water). I actually used it later in my career when designing PID (proportional, Integral, Differential) controllers in power plants.
@Mark,
Good for you. My point wasn’t that calculus is worthless. My point is that it isn’t sufficiently integral (see what I did there?) to success in everyday life to warrant requiring it in high school.
i assume you are joking. even college students can’t “do” calculus, let alone understand it, and that includes quite a few engineering students and even PE’s.
forced is such a lovely word.
or as the sign on the wall where i worked said: “the beatings will continue until morale improves.”
In much the same way that ‘theory’ has a very different meaning to the general public than it does to scientists, ‘inflation’ seemingly has a different meaning to economists than to the general public.
The colloquial use of ‘inflation’ seems largely to refer to declining living standards due to the cost of living rising faster than wage increases.
John Q. Public doesn’t care about changes in the price level; he very much cares that his food bill has risen 30% over the past four years while his employer is offering a 1% raise per year (if that) and the only way he can get a 20% wage increase is by switching jobs. Even if he switches jobs, Mr. Public would still be worse off than he was in 2020. The state of economics knowledge among the general public being what it is, John Q. Public calls this inflation.
Quibbling over the precise definition of inflation is as unhelpful as arguing over the number of angels who could dance on the head of a pin. The root socioeconomic problem at hand is declining popular living standards, not terminology, and those who pretend otherwise are feeding the beast that is reactionary politics.
nobody
yes. exactly
as we learned from the Boskin report, “when the price of steak goes up, people can switch to chicken. therefore inflation does not exist. and when the price of chicen goes up people can switch to turnips.”
to those who worry about such things: the words between quote marks above do not legally imply that anyone spoke those exact words. [except, of course, me.]
but i think Baker was pointing out the ways reliable news sources use words to mislead the people willing to be misled.