One of my hobby horses – what is inflation?
Arthur Seldon defines inflation as ‘a fall in the value of money due to a persistent expansion in its quantity’. Ludwig von Mises wrote that ‘everyone knows’ that inflation is an increase in the quantity of money. Furthermore he wrote that ‘everyone knows’ that a general increase in prices is a consequence of inflation. Yet, inflation is often defined as a sustained increase in the general level of prices. This latter definition, however, is unsatisfactory.
The Australian is reporting that the CPI contains a flaw, with the following headline:
Inflation figures contain ‘massive flaw’ for potential homebuyers, says CBA
The story is:
The true challenges confronting young Australians seeking to buy their first home are masked by a “massive flaw” in inflation data, according to a new report from Commonwealth Bank’s economics team.
The note, authored by CBA senior economist Gareth Aird, finds potential homebuyers are neglected by official inflation numbers, given the figures ignore the recent dramatic surge in house prices.
As it stands, the core measure of cost-of-living pressures used by analysts is the Australian Bureau of Statistics-released consumer price index (CPI), which does not factor in increases in land values.
Mr Aird contends the exclusion of the single largest purchase an Australian will likely make serves as a “massive flaw” in using CPI as a proxy for cost of living pressures. However, he stopped short of arguing for changes in land values to be incorporated in CPI.
Now I am sympathetic to the argument that the Consumer Price Index contains flaws. This must be true almost by definition. But it isn’t clear to me that the CPI should include house prices. It also isn’t clear to me that CPI is a comprehensive measure of inflation – it is a proxy for inflation but in and of itself isn’t inflation. Changes in the CPI will be due to a combination of factors such as inflation, changes in relative prices, and measurement error.
A true measure of inflation would include things such as housing and other investments and the like, but that isn’t the role of the CPI. This conflating changes in CPI as being inflation does lead to problems, however, as people think inflation is subdued; but Australians are facing price pressures, and a declining standard of living – why did nobody ever warn of this happening?