Dr. Stat

Dr. Stat is a Statistics Professor. This blog is his opportunity to share ideas and opinions about education (especially math education), politics, and whatever else comes up.

Tuesday, March 22, 2005

A Study of Inflation

“Everything is so much more expensive now.”
Really?
Prices have gone up. So have wages (the price of labor). So has the quality of many goods purchased. How can we compare today with yesterday, when we are not talking about the same things? Take wages, to begin with. We can compare per capita incomes between two time periods. Or we can compare median family incomes. But is the work the same? Are the hours worked the same? Is the investment (mainly education) in employability the same? Are the sources of income the same (employment vs investment, inheritance, etc.)? In fact, none of these things are constant over time, making comparisons about changes in wages very difficult.

What really matters, though, is what you have the power to buy using the resources readily available to you. Most often, we think of the resource of personal labor, although the use of capital that you control is also a resource. We assume that all capital is built up through the application of personal labor at some time in the past. Therefore it is reasonable to think about how much can be bought using some unit of labor as a standard. However, the capital in an economic system has the effect of increasing the productivity of labor. That is, an hour of labor in the absence of capital is not the same as an hour of labor expended in the presence of capital, such as by using a sophisticated machine. Capital can also be abstract, in that a worker with education or experience has more “human capital” than a worker with neither. And then there are activities that are not easily valued in monetary terms, such as the labor of an artist, whose work may not be valued until he is dead. Some would like to measure the value of labor by “how hard it is,” but even that is not clear since our standards of “hardness” change over time, and what is hard for one person may be easy for another. Furthermore, there is much labor that is not counted in the economy, especially in the past. Consider a farm family circa 1900, with a farmer, his wife, and six children. We would be likely to count this operation as the labor of one man, yet it is likely that there are eight people doing the work. Consider that today, a stay-at-home mom is doing work she is not “getting paid for,” while the same work, being hired out by a “working” mom, is counted in the economy.

There are difficulties in comparing the things that we buy, too. Say we are comparing houses. Is a house bought in 1900 the same as a house bought in 2000? Even if it has the same square feet? No way. And as we look back on this from our vantage point 100 years in the future, our perceptions of this house are not the same as the perception of the original owners. For example, we might think the oak woodwork is extremely valuable, because it would be expensive to replicate today, while the original owners considered it to be quite ordinary. We would consider the lack of an indoor toilet to be a severe deficit, yet the original owners might have considered an outdoor toilet more practical, if they would even have considered anything else. How about a car? Is a Ford Model T equivalent to a Ford you can buy today? Or, how about a horse? Is a horse of 1900 the same as a horse of 2000? Even if the horse is the same, its purpose and value might be very different.

People often think of inflation as being a general trend of rising prices. This is not exactly true. Inflation is actually an increase in the supply of money, which is controlled by the government. When the money supply is increased, the money units are devalued and therefore buy less. In an expanding economy, it would be normal to increase the money supply to keep pace with the increasing value of goods available in the economy. If the money supply increases faster than the value of goods, the result will be a general rise in prices. Contrary to popular belief, government does have very good control over inflation. This control is not immediate in its effect, but over a period of one or two years the government can manipulate inflation to its liking and for its own purposes. Why does the government want inflation? Primarily for two reasons: 1) The government carries a huge debt. As money is devalued, so is the debt. 2) Inflation allows the government to collect more taxes through “bracket creep.” Furthermore, when the public cries out because of bracket creep, the government looks “good” by generously increasing deductions and thus pretending to lift the tax burden. The general population may also have the perception that they are better off because of inflation. This is because they see their incomes “rising,” and although they are aware that prices of goods are rising too, this is not as concrete in their minds as the increase in wages which they can probably recite from memory.