Monday, January 22, 2007

Inflation - A Murky Picture of a Beast

Inflation a standard definition (dictionary.com): a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency

An alternate definition (itulip.com): 1. to an economist, an increase in the general or "all goods" price level resulting from an oversupply of money; 2. to a government statistician, a political football thrown onto the field as producer and consumer price indexes, continuously reformulated and subject to interpretations invented to suit various constituencies over time, such as the under-reporting of home price inflation via an equivalent rent formula when home prices are rising and rents are falling, in order to hide the fact of a housing bubble that is needed to keep the economy from falling into recession 3. to the person on the street, rapidly rising prices of non-traded goods and services, especially insurance, education, and health care, resulting from an excess of cheap credit and the inappropriate use of credit to purchase depreciating assets.

I snagged this neat graphic over at itulip.com and it illustrates how the CPI (Consumer Price Inflation) can remain low despite massive price increases in real estate, health care, education, and most other 'services.' This 'service' price inflation vs. 'product' price inflation is due to the interesting effects of globalization and governmental monetary arrangements that are beyond the understanding of most of the general public.



On a personal observational level, I have definitely noticed the massive price declines of goods made abroad and the massive price increases of goods and services created here in Canada. Feel free to discuss the effects of these differentials in inflation. How do they impact you and your personal choices? Why?

7 comments:

mohican said...

I also wanted to pass along some kudos to VHB for an excellent ongoing piece on inter-Canada migration numbers. Check it out.

ADWeaver said...

Assuming that you could create a perfect CPI; would it include everything?

I understand that they don't include some things in order to avoid skewing the results, but at the end of the day, doesn't an increase in property values help push inflation? Doesn't an increase in the value of any consumer good push inflation?

I guess what I'm getting at is this. If we were to take all the goods/services not included in the CPI, and determined whether they have collectivly gone up or down in price, would this effectivly tell us whether the current CPI has been over or understated?

In your opinion, would this result in an over or understatement of the current CPI (ie. do you belive the basket of goods/services not included in the CPI are collectivly up or down wrt price)?

freako said...

Remember, CPI is NOT inflation itself. It is merely an attempt to gauge CONSUMER price levels. Any rejigging of CPI (for whatever purpose) does not change inflation any more than monkeying with your bathroom scale helps you lose weight. Doing so can, however, hide (or overstate) the situation.

Think of inflation as the result of too much money chasing too few goods. The island analogy really helps. Inflation SHOULD not in itself affect the relative price levels of various goods and services.

Owning a house means that you are investing as well as consuming (equivalent rent). The investment portion is not consumer inflation. If that was the case, the stock market going up would also be inflation.

It is true that many services have experienced relative price increases, and mass produced goods have experienced deflationary pressures. Again, I am not sure whether such a shift in relative value can be "blamed" inflation. Had there been no inflation, the produced goods could have gone down more, and the services could have gone up less. I am not even sure if overall services have experienced the inflation i-tulip implies. Many services have gotten cheaper. In any case, where are these real price increases in services ending up? Pay cheques? Corporate coffers?

Overall, I like what Erik Jensen has to say. However, the most active member of their forums is you know who, and he regurgitates these arguments endlessly on most local RE blogs under various handles. Globlisation this, globalisation that. House prices haven't really gone up, it is just that goods have gone down, etc etc.

So does CPI underreport inflation? Why not ask the people who put their money on it, long term bondholders. I think the near inverted yield curve tells you the answer.

freako said...

Oh, and I am not sure whether i-tulip's health care measured apples to apples. Increased quality of healthcare should be factored in.

Official Canadian numbers have the following for Healthcare services portion:
2001 2002 2003 2004 2005
2.6 2.7 2.7 3.1 3.8

Total CPI is not much that higher:
2001 2002 2003 2004 2005
2.6 2.2 2.8 1.9 2.2

Between 1992 (last reindex), Healthcare services are up 36.1 percent, while CPI is up 27.7.

http://www40.statcan.ca/l01/cst01/econ161a.htm

mohican said...

I think the StatsCan CPI is a fair representation of what the average Canadian spends on consumable items.

Freako: The numbers from StatsCan that you showed would indicate precisely the type of cumulative difference that is evidenced in the iTulip chart. There is a cumulative 20% difference between the CPI and the health care inflation numbers over only five years. Give it 40 years and I think their chart is fairly indicative of health care inflation.

freako said...

"There is a cumulative 20% difference between the CPI and the health care inflation"

That is true, so point taken. Small differences can compound significantly. The difference 13 years back to 1992 is "only" 30%.

As for healthcare, it is a little hard to pin down. How do you value the fact that acute leukemia survival rate went from 14% in 1963 to 49% in 2002? I imagine that CPI calculations at least try to account for the technological and scientific advancements which result in improved quality of care.

mohican said...

I'm not privy to the hedonic adjustments that StatsCan uses for CPI but I imagine that they account for exactly those types of improvements in health care (survival rates, better recovery, quality of life, etc).

I also think that the US has a slightly different picture in health care than we do in Canada since there is far more innovation and development that the US health care consumer pays for that we do not proportionally pay for here in Canada.

I am not apologizing for the iTulip graph but I am trying to rationalize the numbers and they still seem to make sense.