Tuesday, March 24, 2009

The Odd Effects of Inflation

It is a popular talking point right now to harp on how middle class incomes have declined. Of course, in absolute dollars this is not true, but absolute dollars are of little meaning with our constant inflation system of economics. So we use 'real' dollars, inflation adjusted relative to some more or less arbitrarily selected year.

What I think many people fail to consider is that the results of this adjustment are no longer a measurement of a single factor (income), but rather a measurement of two factors (income and inflation). We spend a lot of time debating what those income numbers mean, and what to do about them, but we abstract away the inflation numbers uncritically.

So, as I so often say, step back from policy positions and politics for a moment. Consider this graph. Now, we can talk about trends and variance between groups, but that is not what strikes me about this graph.

What strikes me is how flat it is. Across 40 years, many different administrations, different parties in control, at least one major policy shift in the Reagan years, look at how straight the lines are. Especially note how close to completely flat the 50% and lower lines are.

Statistics don't work that way. This just screams artifact. Somewhere in the equation we have a feedback loop.

Since 1950, the average new house size has well over doubled. We have more cars now than we have drivers. 40inch TV's used to be for rich people only, now 40" ain't that big, and the electronics store has about an acre of them, so people can have one in the living room and the bedroom. I actually saw an add for a 26" flat screen listed as 'perfect for the bathroom or other small areas'. Cell phones, laptops, the Internet, how many people reading this remember when a computer was an extravagance that only the wealthy could have? Now, how many of you have more than one?

And yet I am supposed to believe we are poorer now than then? This does not add up.

The problem is that the staple items, housing most especially, have their price driven by what the majority of Americans (the middle class) are willing to pay. Lowering the price of housing does not cause us to spend less money, it causes us to get bigger homes. But the consumer price index uses cost of housing as it's largest factor. Feedback loop!

When you get down to it, 'real income' does not measure what you get, it measures what percentage of what you get is left after paying for the basics. It takes no account for how much you can get with that percentage.


TAO March 24, 2009 at 6:04 AM  

You are missing one very important statistic that must be included in any discussion of income and consumer prices and that is personal debt.

If you consider personal debt as wealth then of course we are NOT poorer.

When you realize that the median household income is around 40,000 and the flatest lines fall below that level and those above it are not flat...

Thats an issue.

We can go on and on about consumerism all we want and how that makes each and everyone of us responsible for our own stupid money habits but we also must acknowledge that that same consumerism created a tremendous amount of wealth for others also....

If I bought too much then someone earned too much.

OpenMindedRepublican March 24, 2009 at 6:49 AM  

I sometimes wonder if there is a correlation between debt and political views. Or vocation for that matter...

Most of the people I know carry very little debt outside of their mortgage, and have solid equity in their homes.

I have basically no debt at all.
Makes it hard to get too concerned about the economy. My creditors can't take everything I own, because I have no creditors. Mind you, I have less stuff than those people I know who think the monthly payment is what something costs. I traded stuff for security. Right now, it sure looks like a good trade.

But how then are we to reduce this? Pushing up the interest rates might do it, but are we willing to face the consequences of that?

TAO March 24, 2009 at 7:08 AM  

Yes, I live in the first home I ever bought...and have lived in it for 20 years. I like my house and have no desire for more. My car is 9 years old and I like it and I have no desire for a new car.

But I know people who have debt levels that I cannot even begin to comprehend.

While it is logical to assume that by increasing the cost of debt service should lower the demand for credit I do not believe at this time that is a logical solution.

I actually believe that lowering the rates of interest on existing credit and credit card debt along with capping the amount of new debt issued based on someones income is the best way to wind things down temporarily.

I am not saying that these are long term solutions but rather short term solutions to solve our current mess and get us on some logical foundation.

We do not need to keep increasing our foreclosure rate and we sure do not need to deal with credit card debt default. It would benefit everyone if we actually froze credit card interest to some really low interest if the borrower agrees not to increase their debt....that way we can unwind from our debt hangover without hurting ourselves.

Of course banks would rant but I think they are in no position to complain right now and that a logical argument can be made that it is better to be paid something and earn less interest income than it is to attempt to risk collecting usuary and end up with nothing but credit default.

OpenMindedRepublican March 24, 2009 at 7:24 AM  

I dunno, the local banks that are in good shape anyways probably would be unaffected.

The big banks that are hating life right now, probably can't get away with saying much anyways.

Not a bad short term fix on the face of it.

(O)CT(O)PUS March 24, 2009 at 8:13 AM  

I think a discussion on the effects of inflation should be parsed into finer detail.

Certain types of consumer debt are highly idiosyncratic and elastic, with the operant word being "elasticity." Impulse spending, for example, is highly elastic; spending on staples is inelastic. So we need to be more specific about the effect of inflation on overall debt.

Consumer electronics, a case in point, has actually gone through a period of deflation.

Staples such as food, energy, healthcare, and housing have risen faster than the base inflationary rate such that, if wages remain stagnant or rise slower than the base inflationary rate, then living standards are compromised.

If the expenditure is inelastic, meaning "you gotta eat no matter what," then savings shrinks to zero and debt is much more likely to be accumulated. This is not an aberration: There are folks piling up credit card debt just to meet basic expenses ... because staples costs have risen faster than wages.

Overall, a very sad state of affairs.

Time March 24, 2009 at 11:51 AM  

Use to be that one wage earner in a family earned enough to pay all the expenses of the family. Now it takes two wage earners in the family to pay for the same needs. And a lot of people are working two jobs.

Stagnant or lowering wages along with inflation counts for most of it, but peoples level of lifestyle is higher these days, to high by my personal habits, but overindulgence is not the whole problem.

Boomers were spoiled and are spoiled. They have (generality) spoiled their children.

Americans don't save money. Our saving rate has always been below what is needed.

Americans buy everything on credit. I cringe every time I see someone buy a cup of coffee and charge it. I have seen people charge a pack of gum! Stupid!

The 3 of us are not the average consumer. Most Americans are deep in debt, which is why there is so much worry about this financial mess.

Last I checked the average American had more than $10,000. on credit card debt. Most Americans are paying to high a % of their income for a place to live, or transportation. Younger people have thousands in College debt that will take years to pay off, if they can find a good paying job.

I have a truck that is 10 years old with only 55,000 miles on it.
I paid cash for my home (bought foreclosure and fixed it up myself)I paid about the same for this home as I paid for my truck. My phone bill is $23.00 a month (I have no cell - I am a dial up computer person - I pay lifeline cable $10.00 a month - my TV is 7 years old and works fine. I buy food in bulk and vacuum freeze. I don't drink or smoke. I don't eat out much because I cook better than many chefs. I carry cash, not a card. I have an American Express, use if for big ticket items, then pay it off in full at the end of the month. I clip coupons, and on, and on. My brothers think I'm the cheapest guy in town, they are probably right.

Everyone I know squeezed into a house that was more than they could afford and to big for their needs.

It's not just the poorer people that got these ballooning loans. Many households are 6 months away from bankruptcy if they lose their jobs. Some less, some are already in the streets.

Americans will be forced to live a lowered lifestyle, especially if we are to compete with the workers of the World who earn much less than we do. Our wages are not going up anytime soon.

I should have written my own post, but my blog has been locked by Blogger. Apparently someone reported me as a spammer? My blog is under review and I expect to pass that review, but I have a back up blog with only my essays. No guest writings, cartoons, or other stuff. Check it out:


OpenMindedRepublican March 24, 2009 at 4:22 PM  

Octo - "Staples such as food, energy, healthcare, and housing have risen faster than the base inflationary rate"

As far as I know, the staples you list are the base inflation rate, at least as applies to the concept of 'real income'. That is, in a very real sense the point of my post.

Looking over the past, one finds that the cost of living is driven by what the middle class is willing to pay for it. As such, increasing their income will not move this number. Not just won't move it much, flat out won't move it at all.

TRUTH 101 March 24, 2009 at 4:59 PM  

Your site is rocking OMR. As a smalltime hack and plain old working stiff, my simple observation is that if you and your wife aren't pulling down at least 70 grand a year between you, you're struggling to make ends meet if you have two or more kids.
When I as a lad, 30K a year was good money. 50 K was country club time. Maybe it's all relative with inflation, but most of the people I know are in the 70 to 90k bracket and don't have much left at the end of the month. You can live like a king owing thousands of dollars. I think that is a big reason for much of the prosperity the last 8 to 12 years. Prosperity through borrowing. Looks like the spigot is dry now. I'm lucky to have a relativley safe union job in a safe industry. I feel bad for those that don't enjoy the security I have.

(O)CT(O)PUS March 24, 2009 at 6:56 PM  

As far as I know, the staples you list are the base inflation rate ...

Not exactly. Base inflationary rates are calculated on the basis of composite indices (something like GDP). Some sectors, such as consumer electronics, have seen deflation while others have seen inflation.

The indicators that count the most, of course, relate to what it takes for a family to survive, and composite indices can be misleading ... even downright false.

One can actually have low inflation and increasing poverty ... which the experience of the last decade confirms.

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