Reliable Inflation Calculation

How do calcuate inflation reliably?  Or is there no one set method?

The only really reliable way to calculate inflation would be if we had accurate statistics as to the change in the money supply.

I assume that you are using "inflation" in the Austrian sense, as an increase in the stock of money.

First, you have to decide what "money" is.  There is no consensus among Austrians.  Are savings accounts to be included?  Rothbard argues yes, Shostak no.  Time deposits?  Rothbard argues yes, if they can be cashed in prematurely.  Shostak, no.  MMMF accounts - retail or institutional?

Personally I favor MZM as the best measure of the money supply, since it measures all demand claims to dollars.

I use inflation in the sense of purchasing power.  How much will $1 get me today, versus in 1980?  For instance, if I wanted to calculate the price of gas today, versus the price of gas in 1980, are we paying more, less, or about the same with respect to inflation?

If there is no absolute way to calcuate inflation, what methods will give a far more accurate and precise answer?  Is there even a way of knowing?

Most factors in the economy are variable - money supply, wages, the scarcity of basic resources etc. So if you want to compare between 1950 (or some other date) and today then you'll have to find something that's not variable.

Some people use gold for this. However, the value of gold depends, as with anything, on it's utility to those that value it... and gold was obviously much more valuable when it was used as money  - since it is not used as money by most people today, the value of gold is obviously much less than it would otherwise be if it was still used as money, as it was (in part at least) in 1950... so comparing the price of items in terms of gold is also a bit misleading.

Perhaps one way of looking at things is in terms of what you need to sacrifice to obtain them and ultimately your single most scarce resource is your time... so you could price things in terms of the time you have to spend to obtain them. If you earn $15 an hour and a hamburger cost 3$ then you have to spend approximately 12 minutes of your time working in order to obtain a hamburger.

However, there again, the calculation is somewhat misleading. If the job you do to get $15 and hour is digging coal or if it's giving German lessons then you might not consider those two "sacrifices" to be equal (even though you spend the same amount of time on each). So even calculating the price of items in time is not going to give you precise results.

Or perhaps you're trying to work out how much the dollar has depreciated in value? In that case, simply measure the quantity of dollars in existence (i.e. total money supply). Be careful with this one though - the "value" of a dollar is precisely in what it can buy you. So if you wanted to buy, for example, petrol and the quantity of dollars stays stable but the price of petrol went up for some reason, then your buying power would have beed reduced. However, at the same time the quantity of rice on the market might have gone up and so the price of rice gone down - meaning your purchasing power with respect to rice would have increased. If you were concerned with both of those products (and only those two products) then perhaps your purchasing power as an aggregate would have stayed the same...

It all depends what you want to spend your dollars on really... but personally I think dollars are a wild goose chase - they hide the really important stuff. More important to you and I are the cost (in terms of labour and other sacrifices) of the real goods we need like food and housing, or the stuff we want (like DVD players) but don't need... but which never the less substantially affect our standard of living.

Changing the quantity of dollars in supply will likely impact our ability to obtain these real things in as much as it impacts the value of our savings (and thus past labour and sacrifices) and in as much as prices in the market will not be able to react immediately and perfectly/uniformly to money which is added/removed from the system... and generally money supply only ever goes up (inflatino), thus eating away at our savings and dilluting the value of work we've performed in the past. Unless you're one of the beneficiaries of the new money then, the "value" of dollars is ever decreasing - by exactly how much will depend on exactly what it was you wanted to spend the money on... which is very very tricky to calculate indeed.

Jimmy is right.  There is NO particularly good way to measure loss of purchasing power.  On this Mises says:

"The pretentious solemnity which statisticians and statistical bureaus display in computing indexes of purchasing power and cost of living is out of place. These index numbers are at best rather crude and inaccurate illustrations of changes which have occurred. In periods of slow alterations in the relation between the supply of and the demand for money they do not convey any information at all. In periods of inflation and consequently of sharp price changes they provide a rough image of events which every individual experiences in his daily life. A judicious housewife knows much more about price changes as far as they affect her own household than the statistical averages can tell."

The CPI is not very helpful.  It might be more helpful if it took into account rises in share-prices or house-prices, and if it weren't distorted by "hedonic adjustments" and the like.

The price of gold is misleading because it was held below its market-value until 1971, and then it ricocheted up to a stratospheric level in 1980, only to slowly fall back.

The price of land, labor, housing, a loaf of bread, a tank of gas, is as good an index as any other.  If you know exactly what you spend your money on in a year then you can extrapolate back to calculate your own personal CPI-rate.

LanceH:

The price of gold is misleading because it was held below its market-value until 1971, and then it ricocheted up to a stratospheric level in 1980, only to slowly fall back.

None of that explains why the price of gold would be misleading today.  I personally think it's a pretty good indicator of a currency's purchasing power.  It's still (by far) the most monetary of all commodities, meaning is should be more sensitive than other commodities to money demand.  Looking at monetary aggregates only reveals info about the money supply and nothing about money demand, so it's of limited use when trying to estimate changes in purchasing power.

maxpot46:

None of that explains why the price of gold would be misleading today.  I personally think it's a pretty good indicator of a currency's purchasing power.  It's still (by far) the most monetary of all commodities, meaning is should be more sensitive than other commodities to money demand.  Looking at monetary aggregates only reveals info about the money supply and nothing about money demand, so it's of limited use when trying to estimate changes in purchasing power.

The question I ask myself is "What would happen to the price of gold if the USA, Japan or China decided to use a gold backed currency tomorrow?" Surely the price would go up, wouldn't it - since gold would then have increased monetary usage and increased value (it's new found monetary value)... So basically what I'm saying is that gold is NOT really used as money today. The majority of it is held by central banks and it's price is controlled, to a large extent, by when and how much gold those central banks decide to sell into the market. It is not held in the hands of people like you or I and used as a medium of exchange to facilitate the purchase of all the goods and services that we contract in our day to day commercial exchanges - so surely it is a stretch to say that gold is used as money today.

In light of that fact, surely gold's value (and indeed it's purchasing power) was much greater when it WAS used as money - i.e. back when gold and silver coins were in circulation. And it's value was probably greater even after actual gold/silver coins went out of circulation but, at least, central banks backed their currencies with gold and settled with one another using actual specie. As such, trying to compare prices in terms of gold, between a period in history in which gold was used as money (and had thus increased value) and today (where it's monetary value is largely non-existent) is going to be quite misleading. Today's prices, in terms of gold, are going to be largely overestimated. If we had a gold based money system then gold would have more value and greater purchasing power - the value of gold relative to the value of other goods in the economy would be greatly increased by a return to a gold based monetary system.

maxpot46:

None of that explains why the price of gold would be misleading today.  I personally think it's a pretty good indicator of a currency's purchasing power.  It's still (by far) the most monetary of all commodities, meaning is should be more sensitive than other commodities to money demand.  Looking at monetary aggregates only reveals info about the money supply and nothing about money demand, so it's of limited use when trying to estimate changes in purchasing power.

I agree with you.  I meant only that no market price for gold is available for several decades up to 1972, and that historical comparisons therefore are valid only outside that period.

Mark Skousen (Dec 12, 2005) found that gold was a good leading indicator for the CPI:

"Recently, I ran an econometric model with the assistance of John List, a top economist now at the University of Chicago. We tested three commodity indexes (Dow Jones Commodity Spot Index, crude oil, and gold) to determine which one best anticipated changes in the Consumer Price Index (CPI) since 1970. It turns out that gold proved to be the best indicator of future inflation, as measured by the CPI - even better than oil. The lag period is about one year."

As to Jimmy's point about the loss of value of gold due to demonetization, it has certainly lost some value but how much is impossible to say.  Perhaps we could look at what happened to the price of silver when it was effectively demonetized by bimetallism, but even there it would be hard to isolate the monetary component from other factors such as increasing mine-supply.