What’s the inflation rate? Depends who you ask.
How much did prices increase last year?Economists and financial analysts will say 0.7 percent, as the Bureau of Labor Statistics reported in the Consumer Price Index. That’s the indicator the government traditionally refers to as the official inflation rate, but many Americans believe it dramatically understates “real” inflation. ShadowStats, a website frequented by inflation skeptics, puts inflation closer to 10 percent in 2015.
That’s a huge difference. In surveys, Americans also offer a wide range of estimates for inflation, anywhere from 15 percentage points or higher to actually decreasing**.**
Inflation—both the real number, and people’s perception of it—is crucially important for economic policy. In Washington it helps drive major moves like interest rate-setting; at home, consumers may make spending decisions based on their expectations of price increases, so this level of uncertainty is a problem for understanding the economy. What’s going on?
Now a new study offers a clue. Economists have historically argued that Americans’ estimates of inflation are so wrong because they either don’t understand inflation or misunderstand how much prices are actually increasing. But a new working paper, released by the National Bureau of Economic Research this month, suggests a potential new explanation: American households experience inflationvery differently, and their estimates of inflation vary accordingly. In other words, inflation isn’t just one thing: it varies widely from household to household. So their responses aren’t wrong; they’re just based on personal experience. The findings could have important implications for monetary policy.
The new paper offers the most comprehensive look at how prices vary for individuals at the household level. Economists have long known that the specific prices each American pays for goods and services will vary depending on geographic location, time and other factors. Chicken breasts in New York City may cost more than an identical product in Omaha, Nebraska. This paper wasn’t looking at prices for a given time and place, but was instead looking at the annual change in prices—inflation—for specific households over time.
“When we measure inflation typically, we measure inflation for a single bundle of goods, a basket like in the Consumer Price Index,” said Greg Kaplan, an economist at the University of Chicago and co-author of the paper. “Effectively that assumes that every household is facing the same prices of goods. We all understand that there’s a lot of differences in the population in terms of what prices we actually face for different goods and we wanted to get a measure of how big those differences were.”