March 6, 2022
by Stephen Stofka
In trips to the grocery store and gas station, many of us develop an inflation calculator that we trust because it tracks price changes in the unique basket of goods that we buy. If the price of mushrooms doubles, we only care if we buy mushrooms. Economists have the difficult task of computing the price changes of a common set of goods. They spend an extraordinary amount of time and expense surveying people in cities throughout the U.S. to construct a representative sample of the goods we buy (BLS, 2021). The price weighting that economists use to measure inflation differs from our instinctive approach. We assign weighting by the frequency we do something. What catches our attention gets more weight in our consumption basket.
Our sense of inflation can be guided by the price of gasoline when we fill up each week, but it is only 4% of the CPI measure of inflation (BLS, 2022). Many of us underweight the cost of housing that we provide to ourselves. Wait, what? In January, economists at the Bureau of Labor Statistics computed a 4% increase in housing costs even for those who owned their home outright. They call this Owners’ Equivalent Rent (OER) and it makes up a whopping 25% of the calculation of inflation. In the BLS methodology, homeowners are both landlords and renters. Actual rental increases made up only 7% of the index but the BLS uses those rent increases to compute the market price of what a homeowner could rent out their home for each month. For a homeowner, that 4% increase in housing costs is actually a 4% saving. Even better, homeowners do not pay income taxes on that imputed income.
Like gasoline, we overweight the effect of grocery prices because we frequently shop. If we enjoy a sirloin steak once a week, we notice when it increases in price from less than $10 to $13 a pound (FRED series APU0400703613). In the years after the financial crisis many households ate more ground beef. Prices doubled in response to the increased demand (APU000070312). Ground beef is what economists call a Giffen good. Unlike normal goods, we buy more of a Giffen good when our income goes down.
Many of us measure inflation by comparing the prices we pay to the wages we receive. Workers have gained little in the past two decades, eking out an extra 8% in real earnings over that time. All of that gain has come in the past eight years. Workers should expect to share in the productivity increases of the past two decades.
An assumption of neoclassical economics is that workers’ wages reflect their marginal productivity. A BLS analysis (Sprague, 2014) of labor productivity showed an average gain of 2.2% in real output per hour from 2000-2013, yet workers’ real earnings declined slightly. In the past eight years, annual productivity gains have averaged about 1%, slightly below the annual 1.2% increase in real wages. Why have workers been able to command wages appropriate to their productivity in the past eight years but not in the 14 years prior? The problem began before the financial crisis when productivity rose 2.7% per year and real wage growth actually declined. The 2000s came after a period of reversal for the owners of capital. During the 1990s, much money was lost in the pursuit of profits promised by the developing internet. Owners and management recaptured those losses by keeping the productivity gains to themselves during the 2000s. Workers may not be able to regain those lost wages but at least they are securing the fruits of their labor.
Photo by Timotheus Fröbel on Unsplash
BLS. (2021, December 9). Consumer price index frequently asked questions. U.S. Bureau of Labor Statistics. Retrieved March 5, 2022, from https://www.bls.gov/cpi/questions-and-answers.htm
BLS. (2022, February 10). Table 1. Consumer price index for all urban consumers (CPI-U): U. S. city average, by Expenditure Category – 2022 M01 results. U.S. Bureau of Labor Statistics. Retrieved March 5, 2022, from https://www.bls.gov/news.release/cpi.t01.htm
Sprague, S. (2014, May). Definition, concepts, and uses. U.S. Bureau of Labor Statistics. Retrieved March 5, 2022, from https://www.bls.gov/opub/btn/volume-3/what-can-labor-productivity-tell-us-about-the-us-economy.htm