(Originally published here.)
Defining inflation is easy — a rise in the price of goods and services — but measuring it is really hard. Air Canada’s plan to cram more passengers onto its planes is a case in point.
In addition to shortening seat bottoms and compressing seat backs, the airline will probably reduce legroom by a few inches to bring it in line with the industry standard. These changes will degrade the customer experience, so even if Air Canada ticket prices don’t go up it seems reasonable to think that the effective cost of flying on the airline will rise. (That’s presumably what Air Canada’s shareholders want, given that the company reported net losses in five of the past six years.)
These kinds of hidden price increases are often left out of inflation statistics. In the U.S., inflation is measured by both the Bureau of Labor Statistics, which produces the consumer price index, and the Bureau of Economic Analysis, which produces the deflators used to translate nominal spending into real gross domestic product. Both agencies are familiar with the challenge of adjusting for quality and have written excellent primers describing how they cope.
Traditionally, the biggest problem has been figuring out how to account for consumer electronics that still cost hundreds or thousands of dollars even though they are literally millions of times more powerful than previous generations. The BLS chart below reflects this so-called hedonic quality adjustment for televisions:
Although nominal television prices may have stayed the same or even increased, TV costs have plunged once they are adjusted for quality.
Although the BLS and BEA have a lot of experience adjusting electronics, clothes, construction costs and textbooks for changes in quality, they mostly ignore other things people spend money on. This is because it’s harder to gauge changes in the quality of a service than screen resolution or processing power. Is your neighborhood noisier or smellier than it used to be? Unless your housing costs fall by some commensurate and hard-to-define amount, that’s inflation. Do you have to wait in line longer to see the doctor? Again, unless the price of a visit falls, you are experiencing inflation.
Perhaps the most pernicious example of hidden inflation in the U.S. is the way we look at food prices. The BLS is assiduous in measuring the cost of many individual items of food and its staffers should be commended for their dedication. But they don’t adjust for nutritional content. There is no quality adjustment process for mercury in your fish, pesticides on your fruits and vegetables, or antibiotics and hormones in your meat and poultry.
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