How a virus can disrupt inflation statistics
The seismic economic disruption of the pandemic has suddenly and drastically changed the spending habits of consumers around the world, leaving official inflation data unrelated to what they are experiencing.
Spurts of price growth in many major economies are worrying investors and central bankers. But part of this trend can be blamed on Covid-19 – with significant implications for how we interpret official data.
Inflation is measured using a basket of goods and services that are supposed to represent what people typically buy. Items are given a weight proportional to the amount spent on them.
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DAY 1: Advanced economies haven’t faced a rapid rise in inflation for decades. Is this going to change?
DAY 2: The global consensus among central bankers on how best to foster low and stable inflation has collapsed.
DAY 3: The canary in the coal mine for inflation US: used cars.
DAY 4: How a virus can disrupt official inflation statistics.
DAY 5: Why rising prices in advanced economies are a problem for indebted developing countries.
All over the world over the past year, as the pandemic took hold, people stopped spending on restaurants, airline tickets and other lockdown-restricted activities virtually overnight.
As a result, some countries’ real-world inflation experience differed from the official headline rate by up to 0.89 percentage point in a single month last summer, according to research by Harvard professor Alberto Cavallo. . US inflation may have been underestimated by 5.5 percentage points during 2020 according to Cavallo’s estimates.
The dislocation is expected to continue as major economies return to more normal consumption patterns, economists have warned, making it more difficult to interpret the official measures of price change that are the primary focus of consumer policy. central banks.
The details of the inflation calculations in the United States and the Eurozone are different, but the two methods pose the same challenge.
The inadequacy of the American calculations
The US Bureau of Labor Statistics uses survey data that delays real-world changes by two years. So, since the start of the pandemic, official inflation data has been calculated using weights that reflect the pre-pandemic world.
Measurement error is particularly acute in two categories.
Grocery spending rose 29% in March of last year, according to credit and debit card purchase data from Opportunity Insights. The surge in demand pushed prices up 2.7% month-on-month.
In contrast, transportation spending fell 70 percent in April last year, and prices have fallen 7 percent since the start of the year. The effect has lasted: transportation spending was still 25% below pre-pandemic levels in May of this year.
According to economists, the net effect is that the official calculation of the Consumer Price Index has underestimated the price changes people have experienced in their daily lives.
“You can easily see why the CPI was a bad measure of inflation during the pandemic recession,” said Miguel Faria e Castro, economist at the Federal Reserve Bank of St. Louis. “This recession has brought about an unprecedented change in the composition of household consumption. “
With the reopening of the US economy and the end of the blockages, the effect has reversed.
For example, a decline in the production of cars and trucks over the past year has pushed up prices for used vehicles. Given that Americans have spent less on transportation since the start of the pandemic than the CPI weighting suggests, the official April inflation reading – which jumped big – was likely an overestimate. .
“In April, what caused a third of the jump was actually in used cars and trucks. That was a big factor, ”said Cavallo, who used real-time spend data from Opportunity Insights to reweight items in the CPI basket to more accurately reflect recent price changes.
“The CPI basket should have put less weight on [transport], and [then] you get lower inflation in April, ”he said.
The problem of the European reset
Unlike the United States, euro area inflation weights are updated annually in January. Changes in consumption patterns during the pandemic mean this year’s calculation will place little weight on the prices of items such as gasoline, hotels and restaurants, affected by lockdowns last year.
As a result, even if European consumers return to pre-pandemic spending habits as the economy normalizes, official statistics will underestimate spending in these areas.
Carsten Brzeski, economist at ING, said that “interpreting this year’s inflation data will not be an easy task” as pandemic-era spending creates distortions not only during lockdown periods “but also later this year with [consumers] return to normal consumption patterns ”.
This means that official inflation statistics are “less precise,” said Gregory Claeys of the economic think tank Bruegel. “We are going to have the same problem as last year, but reversed,” he warned.
The effect could be significant. For example, the weight of leisure and personal services and restaurants and hotels fell by 40 and 30 basis points respectively in 2021 compared to the previous year. On average over the past 24 years, these spending areas have changed by only 0.6 basis points per year.
The problem is already visible in the case of gasoline: prices and consumption volumes fell last year. Gasoline prices are rising again, but its influence on the calculation of headline inflation will be 13% lower than last year – and this effect will last until the inflation basket of the euro zone is again redefined in January. The same trend could occur with hotels and cinemas.
The European Central Bank calculated that consumer inflation last year was 0.2 percentage point higher than the official CPI between April and August, and the change in weight this year raises the inflation rate by 0.3 percentage point in January.
Katharina Utermöhl, senior economist at Allianz, said policymakers “will need to take note and test alternative measurement methods to get a better idea of the real dynamics of inflation” – as these statistical problems continue to take their toll. with the CPI in the coming months.