Inflation Is Higher Than the Numbers Say

While government statistics say inflation is low, the reality is that the cost of living has risen during the pandemic, especially for poorer Americans.

By Justin Wolfers

The latest inflation statistics say prices have risen by only 1 percent over the past year. But there’s something wrong with those numbers because the pandemic has made economic life more expensive in ways the official bean counters aren’t capturing.

This distortion has led other economic statistics to paint an artificially rosy picture of our current situation. The problem is that measures like real output, real wages and poverty are calculated using inflation adjustments that don’t reflect the higher cost of living during a pandemic. This might help explain why measured poverty has fallen even as lines at food banks have grown.

The government’s approach to measuring inflation is straightforward enough. The Bureau of Labor Statistics tracks the price of a basket of goods and services that is intended to represent average American patterns. The inflation rate is the monthly percentage change in that price.

But no economic statistic can perfectly track the cost of living. In normal times, the government’s numbers are thought to overstate the true rate of inflation. But the pandemic has upended the economy in ways that have reversed these biases, so that the official statistics are now an underestimate.

People are buying more of those goods whose prices are rising the fastest.

The Consumer Price Index tracks the cost of a fixed basket of goods, but people constantly change what they buy. This “substitution bias” usually leads inflation statistics to overstate changes in the cost of living, because people tend to substitute lower-cost alternatives when prices rise.

But since the coronavirus hit, people are buying more of the essentials, like groceries, forcing their prices up. And they’re buying fewer airline tickets and less gasoline and clothing, pushing those prices down.

Alberto Cavallo, an economist at Harvard Business School, has mined credit and debit card data and found that these changing buying patterns are especially important for low-income households, which devote a larger share of their spending to food.

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