Let me use an article in the Financial Times a couple of weeks ago1 as a basis to comment on inflation, inflation rates, and inflation indices during the pandemic. I’ll quote sections from the article (they will be in italics and indented) and then comment on them.
The cost [i.e., price] of many goods and services that have become popular with eurozone consumers during the pandemic is rising far faster than the bloc’s overall depressed level of inflation, an analysis of official data by the Financial Times has found.
This is just supply and demand. If people want more of an item, i.e., if the demand for an item goes up, then its price will go up. If the demand for other products stays about the same, then the price of the original item will go up more than the average price, i.e., the overall rate of inflation.
Economists polled by Reuters expect the headline inflation rate for November to come in at minus 0.2 per cent when it is published today. But this downward price trend is partly driven by a drop in the cost of goods and services, of which consumers are buying less or have stopped purchasing altogether because of changes in lifestyle due to the pandemic, FT analysis suggests.
Once again, it’s logical that the price of things people don’t want or don’t want as much of (because, for example, they can’t use them in a pandemic) will be going down – because the demand for those things is going down. However, if the “headline inflation rate” is going down because the prices of items that people are no longer buying are going down, then that drop in the inflation rate may not be real. (See next comment.)
The analysis suggests the overall [inflation] figure which policymakers use to shape their decisions does not fully reflect the way in which many are experiencing changes in the real economy.
This is very important. It is not surprising that buying patterns, i.e., how much of various products people are buying, change over time. And it is unfortunately true that various indices or averages do not adjust for these changes or take them into account quickly enough. It is a problem, however, when policymakers use numbers that are out of date in making decisions. And, it appears, there may be a higher likelihood of this happening in a pandemic because buying patterns change faster.
To try to take into account the shift in spending patterns, the ECB [European Central Bank] has calculated an experimental inflation index. It has recorded a reading of at least 0.2 percentage points higher than the headline figure in every month since April. In August, the latest month available, this would have prevented eurozone inflation from falling into negative territory.
The experimental measure ‘by design … comes closer to the rate of change in the prices of items actually purchased by consumers during the period’, the ECB said. The alternative inflation measure ‘intuitively reflects consumers switching from lower-than-average inflation categories, such as fuel for transport, to higher-than-average inflation categories, such as food items’.
We need an index that reflects what consumers are actually buying, so this effort is good – and overdue. As I said above, if policymakers use inflation indices to shape their decisions, we need to make sure those indices as accurate as possible.
Frederick Ducrozet, a strategist at Picket Wealth Management said there was ‘no doubt’ that ‘a number of statistical factors’ were pushing the headline rate of inflation lower during the pandemic. The ECB’s alternative index ‘should provide a better assessment of the actual trend in consumer prices’, he said.
Even so, most analysts agree that the overall impact of the pandemic is deflationary. …
Mr. Alexandrovich said that beyond the measurement problem, the pandemic was ‘clearly deflationary’ and the ‘ECB is ‘very worried’.
It is interesting that, even though (i) the alternative index shows prices going up at least 0.2% more than the so-called headline inflation rate every month, (ii) in August this would have meant the eurozone inflation rate was not negative at all, and (iii), per Mr. Ducrozet, there is “no doubt” that “statistical factors” (which I assume refers to the fact the indices are not up to date with respect to purchasing patterns) are pushing the inflation rate lower, most analysts and the ECB think the pandemic is deflationary.
But, even if the pandemic is a little bit deflationary right now, at least part of that is due to the fact that both the pandemic and government restrictions instituted because of the pandemic, are stopping people from buying as much as they did before. People don’t buy what they can’t use, and there are fewer things they can use right now. But when the pandemic is over and when government rules on what people can do are ended (which is mostly a science question with a little bit of politics thrown in, not an economics question), people will start to spend more – because there are more things to do and more places to go. When that happens, i.e., when demand returns because the pandemic and government restrictions end, we may find prices going up and what we thought was deflation disappearing.
Three final comments:
1. Inflation and other indices that tell us something in regular times, will tell us less during a pandemic because buying patterns will change faster than the indices will.
2. If indices, such as the Consumer Price Index (in the United States), aren’t properly adjusted over time, they will slowly become less accurate and tell us less and less as purchasing patterns change. While it is important for policymakers to always remember this, it is even more important to remember this in a pandemic when the indices become inaccurate more quickly.
3. Instead of worrying about deflation during the pandemic, maybe we should wait until the pandemic is over and government restrictions have ended to see what is happening - because a pandemic economy is not a real economy.
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1 Valentina Romei, “Virus stokes twin-track eurozone inflation,” Financial Times, December 1, 2020. The article is behind the FT paywall.
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