Everything you need to know about inflation and how it’s measured

Decisions, decisions.
Decisions, decisions.
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Listen to the seventh episode of the Quartz Obsession podcast season 3 on inflation.

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Kira Bindrim: If you’ve paid for pretty much anything in the past six months, you might have noticed a few changes. Meat prices are up. Fruit prices are up. Electricity prices are up. Furniture prices are up. Car prices are up. Rent is up. Gas is up. How much you’re paid, on the other hand, that might not be up at all.

After more than 20 years of slow and steady price increases, the US and other countries are now dealing with record levels of inflation. And we know how that works: Greedy companies raise their prices, paychecks don’t go as far, and regular people suffer. Right?

Not exactly. Figuring out why inflation happens is more complicated than people realize, and the culprits that tend to get blamed often aren’t at fault. The truth is we also need inflation, at least some of it, to keep the economy humming.

Of course, tell that to a family trying to put food on the table. No matter how complex inflation is, or how little economists agree on it, we know how it makes us feel. And that feeling is one reason inflation has become such a critical indicator for consumers: It’s personal.

This is the Quartz Obsession, a podcast that explores the fascinating backstories behind everyday ideas, and what they tell us about the global economy. I’m your host, Kira Bindrim. Today: inflation, how we get to the prices we pay.

I am joined now by Heather Landy, who is an executive editor at Quartz and who’s with me here in the studio in New York. I’m curious, Heather, if I say ‘inflation’ to you, are there immediate examples that come to mind from your own life experience?

Heather Landy: Yeah, sure. I mean, these days, plenty. But even thinking back, there was this high-end deli turkey meat that I used to regularly buy when it was like $8.99, maybe $9.99 a pound. I didn’t really ever notice the price, like not on a week-to-week basis, and I didn’t really care until one day, in 2009 or so, I got totally jolted by seeing it crossed the $10 mark. And I honestly think that this was my first real inflation awakening. But there’s plenty of other places that you can find inflation. So Starbucks—they raised prices back in October of 2021, and then again in January of 2022, and then said in February that another increase would be coming. And so far, Starbucks addicts seem to be absorbing the increase. But I like the Starbucks example because they’re a good proxy, maybe, for what’s happening to a lot of big companies out there.

Kira Bindrim: I want to back up a little bit and start with just some basics for people. And also I kind of want to wrap my mind around where the current moment fits in inflation history. So let me start with: What is the definition of inflation, and how do we measure it, or what’s our best metric for measuring it?

How is inflation calculated?

Heather Landy: There’s two good ways to think about the definition in basic terms. One is it a rise in prices for stuff that we buy. And the other way to think about it is a decrease in the purchasing power of your money. So what a dollar, or a pound or a euro or a yen will get you. How do we measure it? A couple different ways. In the United States, there’s two main things that we look at. One is the Consumer Price Index, or CPI, which is a basket of goods and services with about 80,000 different items in it. And it’s weighted by the average importance to American consumers. So if more people eat, say, cereal than eggs for breakfast, a change in cereal prices will count more toward inflation than a change in egg prices. Then there’s the PCE, which is the price index for personal consumption expenditures. It’s similar but different in a few key ways. So the CPI is put out by the US Bureau of Labor Statistics, the PCE is put out by the Bureau of Economic Analysis. PCE usually runs a smidge behind CPI, but PCE is the number that the Fed generally has its eye on, so that’s what it’s trying to keep to 2%.

Kira Bindrim: I want to ask you to define two more things because I honestly feel like we have a branding challenge here, which is there are just too many words that end in -ation and I think people get confused. So we’ve talked about inflation, which is price increases. What is hyperinflation?

Hyperinflation vs. stagflation

Heather Landy: Hyperinflation is technically a monthly inflation rate of 50% or more. It has happened more than 50 times throughout world history. We’re nowhere near that now in the United States nor in most countries. So in Weimar Germany in the 1920s, inflation was nearly 30,000%. $1 became equal to literally 1 trillion German marks. In Hungary after World War II, 419 quadrillion percent inflation—that’s 15 zeros. More recent examples, Venezuela, Zimbabwe have had hyperinflation, that money in those countries becomes nearly worthless. And so what you need when that happens is typically a new currency backed by a stable government. So in Zimbabwe, for example, that’s meant using foreign notes, including the US dollar. And there are reports that Venezuelans are using the dollar, too.

Kira Bindrim: So when we hear that stereotypical, ‘a wheelbarrow full of money was necessary to buy one loaf of bread,’ generally that’s hyperinflation?

Heather Landy: Exactly.

Kira Bindrim: Other -ation word: What is stagflation?

Heather Landy: Stagflation is when inflation is rising and the rest of the economy doesn’t look good at all. So, you know, the stock market might be in decline, unemployment might be on the rise, GDP is falling—so the economy is not doing well, and inflation is rising? Stagflation. Not a good situation.

Kira Bindrim: So let’s talk a little bit about what’s going on in this moment. When we say we are experiencing record inflation right now, what does that actually look like?

Heather Landy: Well, we’re not really. I mean, in the US inflation was running way higher, actually, in the 70s and early 80s than it is now. But the annual inflation rate in the United States was at 7.9% in February of 2022, and that’s the fastest pace that we’ve seen since back in early 1982. So, a 40 year high, kind of alarming. Energy has been the biggest contributor to the recent increases, so gas prices have climbed tremendously, just in general, and then with the conflict in Ukraine. But even getting rid of energy, and also food—and again, these tend to be the most volatile categories—the CPI was still up 6.4% in February, also the most in 40 years.

Kira Bindrim: So we’re talking about inflation rates that are 7%, 8%, 9%. And you mentioned earlier 2% as the thing that the Fed is shooting for. Why? Where does that 2% come from?

What is the current inflation rate?

Heather Landy: Yeah, that’s a funny story, this. So the Fed’s been using that 2% target since at least 1996. And a lot of other countries use it, too—Canada, Sweden, Japan, the UK, also the European Central Bank. And it turns out that this framework dates to a 1988 television interview with a guy who was then the Finance Minister of New Zealand, which at the time was recovering from a big spike in inflation that was running at like 15%. And by the time in the interview, it was closer to 10%—so an improvement. And the minister was asked if the government was satisfied now, and he said no, actually, he’d rather see it between zero and 1%. And so he and his teams went back and set a boundary of 2% to give them just a little more wiggle room on that. And then suddenly, Canada settled on a 2% target. And then it was like dominoes—everybody was suddenly setting targets, and 2% was a very common one to hit. So for the latter 90s and much of the early 2000s, the US was actually interested more in a 1.5% target, it turns out. But after the 2008 recession, 2% became the target formally, just to give the economy a little more space to grow, and that would in turn give the Fed a little more flexibility to lower and raise rates as needed. It has been suggested that 4% perhaps might be a better target. We don’t really know, it’s hard to set up formal tests of these things. But there’s a lot of resistance to moving the target, not because a new one might be wrong, but because you don’t want to sow concern in the market that the target can just change on a whim. I mean, that’s the kind of uncertainty that throws markets for a loop and might even be worse than whatever the economic data’s actually being produced. So we’re likely stuck with a 2% target for the next long while.

Kira Bindrim: It’s making me think of what I am going to assume as an even dumber question, but I’m going to ask you anyway. Why isn’t the ideal rate of inflation zero? In other words, like what is the case for prices going up at all?

Heather Landy: You want to see prices going up at least a bit. I mean, that is the sign of a healthy economy, that wages are in fact growing and that people have more money to buy more things. When inflation goes to zero, or turns negative—or deflation—that is generally the sign of a very unhealthy economy. So a little bit is good. You just don’t want it to get to the point where nobody can afford anything.

Kira Bindrim: Everything in moderation, really.

Heather Landy: Exactly.

Kira Bindrim: So let’s talk about what causes inflation and what impacts it has beyond sort of the straightforward impact, which is obviously prices go up. I alluded earlier to this idea that I think a good number of people might have, which is that inflation is largely a byproduct of greedy companies raising their prices to have more money and take it away from the people. I’m going assume that’s not the case. But I’m gonna ask you anyway: Is that the case? And if not, what do we know about what causes inflation?

What causes inflation?

Heather Landy: I mean, we blame corporations for being greedy and for raising prices so that they can profit. But the problem with this argument is that companies are always greedy. That is what they are meant to do, at least in a capitalistic system. They didn’t just stop being greedy for three decades when inflation was running low and then suddenly just decide, in the past year or so to get profitable. They’re raising their prices because their expenses are going up, too. I mean, that’s how inflation works, it’s like this rising-tide-lifts-all-boats situation.

You asked me about the causes of inflation. So, demand—we want more stuff, and just basic law of supply and demand, we can expect to pay more for it. Lately, very relevant to the situation around the world because of covid, the rotation from services into goods, in part because this causes another major factor in inflation, which is supply issues. So we’re spending less on going out to eat or to the movies or what have you, because we’re locked down at home. But suddenly, we want to build that jungle gym in the back for the kids, or get a new TV entertainment system because we’re all home watching Netflix, or what have you. And that’s going to put pressure on the supply of things like lumber. And then we see those prices rise. And you know, expectations, as I talked about before—this is a really important factor in inflation. So if you think your money will be worth less tomorrow than it is today, that your dollar won’t go as far, you’ll buy today and stretch that dollar if you can. And that’s smart from an individual budgeting perspective, but then that also is going to generate more demand for those products in the short term. And that’s going to push up prices all the more. And right now, inflation expectations in the US and in much of Europe are way higher than they’ve been in a long time.

Kira Bindrim: So it’s a combination of supply, demand, and emotion?

Heather Landy: Yeah, that sounds right.

Kira Bindrim: How universal is the experience of inflation? I have to imagine that rising prices for things like food and gas impact people differently depending on their socioeconomics. Is that the case? What do we know about how it’s hitting different communities differently?

Heather Landy: Yeah, absolutely. So in the United States, lower-income households spend, say three quarters of their income on necessities, and high income households are spending more like 30% of their income on necessities. So there’s much less flexibility in the budgets, obviously, of lower-income people.

Kira Bindrim: Other than prices going up, which is obviously the main manifestation of inflation, are there other ways that people might be able to observe the impacts of inflation out in the world?

Heather Landy: A common one, if we can go back to the grocery store, is shrinkflation, as it’s called. So that’s when you’re paying the same or maybe even a higher price for something, but you’re getting less than you used to. The package might be smaller, there might be fewer sheets on the roll of paper towels that you bought, there might be fewer chips in your bag of Doritos, there might be a little less toothpaste in that toothpaste tube. And those three are actually all real examples that we’ve seen in this latest bout with inflation. So, again, your dollar isn’t getting stretched as far, not necessarily because the price is going up, but it’s getting you fewer Doritos than it used to.

Kira Bindrim: I have one more impact question, and I suspect it’s like got the most complicated answer, but let’s go for it. What is the relationship between wages and inflation? What are we seeing in terms of impacts on wages?

Are wages keeping up with inflation?

Heather Landy: This is a confusing one. So it’s a little bit chicken-and-egg. There’s something known as the wage-price spiral, when prices rise as a result of higher wages, but which came first? So recently, we have seen inflation rising. But we’ve also seen wages rising for the first time in a long time in the United States. The wage gains recently have been stronger at the lower end of the wage distribution. And in fact, if you factor in inflation, to look at what the real wage gains are, like what you actually get after you account for inflation, it’s only on average lower-wage workers that are seeing an increase in their actual purchasing power with the money that they’re earning. But overall, purchasing power is falling. So we’re seeing wage gains in sectors that have some of the lowest pay: leisure and hospitality, retail, transportation and warehousing. What does that do? It means that companies that employ those kinds of workers might have to charge more. What does that mean? We’re paying more and so inflation overall is rising. What does that mean? Those workers now want or need even more in order to afford all the stuff that they’re buying at home. That’s the spiral.

Where it actually starts? The economy’s almost like too big for us to really get a handle on that. And the point is, they speed into one another, wages and prices. And, you know, this is actually one of the issues that a lot of people have when the Federal Reserve starts talking about taming inflation. What they’re saying on some level is that wages are rising too quickly and we need to de-escalate this. And that doesn’t sit well politically with a lot of people, for good reason. Even with wages having risen as much as they have over the past few years, I don’t think most people would tell you that they think people who work at grocery stores are making too much money.

Kira Bindrim: After the break: How do you solve a problem like inflation?

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Kira Bindrim: Hearing you talk about inflation, and how we talk about it at Quartz, it’s interesting to think because it’s just this sort of somewhat routine aspect of living in any economy, but it looms so large in people’s minds, it is on the tip of everyone’s tongue right now. When inflation is up, it’s sort of all anyone can talk about. And I’m really interested in sort of separating the economic definition of inflation from this role it plays for us as this is kind of like boogeyman in the economy. Why do you think inflation has that boogeyman reputation? Is it just as simple as no one likes when prices go up? Or is there you know, precedent, or I don’t know, factors that kind of elevated in our minds?

Inflation throughout history

Heather Landy: I think a lot of it is emotional. I mean, we’ve all kind of had parents telling us about when ice cream cost a nickel for an ice cream cone, or going to the movies was a dime, or whatever. But I think the worst part of it, or the scariest element of it, which is probably not the thing that most people are thinking about on a daily basis but maybe is in the back of their minds, is that it can get out of control quickly if it’s not addressed. And to economists, that’s probably the biggest part of the boogeyman effect of this.

Kira Bindrim: Do you think there’s something generational here, too? I’m actually thinking of the Blackrock president who pretty recently said we have an entitled generation that is experiencing inflation for the first time and oh poor them, they go to the store, they can’t get exactly what they want. That seems a little harsh, but do you think there is an element of, each generation gets its tour with recession, and its tour with high inflation, that there’s something a little bit cyclical about this, and Gen Z and the millennials are just facing it for the first time?

Heather Landy: Yeah, I mean, that’s exactly it. There is something cyclical throughout all of this. And, you know, I recently saw a headline that talked about how mortgage rates in the US are now at a whopping 5%. And my dad won’t hesitate to remind you that he bought a house in 1984, with Sterling credit and a 14% mortgage, which is extraordinarily high by today’s standard. So, yeah, there is a generational aspect in terms of who’s experienced what, when. But mostly, and more importantly than that, there’s a monetary aspect to it. So back in the 1960s, Milton Friedman, the famous economist, noted, ‘Inflation is always and everywhere a monetary phenomenon,’ which became a famous phrase. If you look at the money supply, and it’s rising, look out, because inflation everywhere, since Friedman said this, and probably well before, has largely been the outcome of a rise in the money supply or a rise in the growth of the money supply. That’s where inflation really comes from. That’s what stoking demand, there’s just more money sloshing around. And in this case, with the pandemic, a lot of governments, United States included, really went to town pumping the economy full of money in order to keep things afloat. And that’s a big part of what we’re seeing now.

Kira Bindrim: Okay, now, let’s talk about how you address inflation. So we are in this moment in the US where inflation is at, not a record of all time, but a record for certain generations, let’s say. And everyone’s freaking out about it. Everyone sort of comes around to the idea that it’s not transitory, it is a problem that needs to be addressed. My first question for you is who addresses inflation? Whose job, whose responsibility is it to try and maintain that 2%, or maintain a certain level of inflation, and react if it runs too hot?

How the Fed controls inflation

Heather Landy: Well, that would primarily be the Fed. So we talked about that 2% target that they have for inflation. They also are responsible for keeping the US economy at maximum employment. And this is actually a really tricky balance when inflation starts to rise because the typical way that you stop inflation in its tracks is to ratchet up interest rates. You make money more expensive to borrow. There’s less investment happening, less spending on stuff. But you do that, and then it’s very easy to tip into a recession, and then you see people getting laid off and businesses closing. So those two mandates that the Fed has are often in opposition to each other. So it’s a tricky balance.

Kira Bindrim: We’ve gone through some historical examples of hyperinflation. Is there a good historical example of successfully taming inflation? Would that just be the last time we had high inflation?

Heather Landy: Yeah. The 1980s, Paul Volcker, he came in and did the painful work of really raising interest rates, like to 20%. It was painful. The recession as a result was super deep. But it did slow things down enough to whip inflation, as they called it, and to restore confidence in the dollar all around the world. Because suddenly, the purchasing power of the dollar, you didn’t have to worry about it diminishing as quickly as you did back when inflation was running hot. And this triggered a real era of prosperity. But it’s important to note that that prosperity that we enjoyed in the 90s and early 2000s, was not shared equally. And it made us complacent about a lot of things that we then really started to take for granted in our economy.

Kira Bindrim: Is some inflation easier to whip than other inflation?

Heather Landy: Yes and no. I mean, to the extent that inflation is the result of what the Fed would call a transitory situation, kind of an impermanent, a hiccup, a supply chain issue that can be relatively easily resolved—that can be easier to clear up. The problem that the US has now is that what looked to maybe be a temporary hiccup in things like supply chain either wasn’t, like it was more than just that, or that temporary hiccup sort of, I’m gonna mix all kinds of metaphors here, bled into other areas of the economy. And now we’ve seen broad-based inflation take hold in a much more permanent way.

Kira Bindrim: Is there a world in which inflation resolves itself? Common-colds itself? Just burns itself out without any intervention?

Heather Landy: We don’t really know. But rising rates would be the way to go. The Fed support for the economy in other ways can also get unwound. And you will see that happen throughout 2022, for sure. The Fed had stepped in and was purchasing bonds on the open market just to keep everything afloat during the covid crisis, similar to what it was doing in 2008 during the credit crisis. But generally, higher interest rates have been the solution to inflationary periods,

Kira Bindrim: There is so much to return to here. And I feel like I’ve gone from like, I’ll be at the grocery store and I’ll see the raspberries are expensive and I’ll be mad, to now I’ll be like, ‘That’s complicated.’

Heather Landy: It’s complicated, and not. So I keep perspective in two ways. One, I think about all the things that I want for the world. I want people who are fairly paid, wherever they may live and wherever they may work. I want technologies and companies that are better for the environment, and that costs money to develop and to implement. So it could be, even with all the inflation that we’ve been experiencing since the start of covid, we still might not be paying anywhere near what we should be for those of us who are maybe a little more idealistic about what the economy should be providing to humanity.

The other thing I think about is that historical perspective. The worst ever annual inflation rate in the US ever recorded was back in 1778, just shy of 30%. There were three more periods of double-digit inflation between then and 1913, which is when the Federal Reserve came into the picture. And at that point the data got a lot better, that’s when the CPI got introduced. But four years after the Federal Reserve was created back in 1917, inflation was still just under 20%. So you know, it’s a volatile history.

But if we want more recent perspective, I think of and have been reading a lot lately about the 70s and early 80s. So Richard Nixon comes into office, he inherits a recession. And even though he was a Republican, and Republicans tend to be more conservative about these things at least on paper if not in practice, as history has now shown us many times, he took a Keynesian approach and ran budget deficits. So he’s amping up government spending to keep the economy afloat. And then in 1971, he institutes wage and price controls, which was a new thing for the States, but this sort of pact about how the government wanted to make the economy work for more Americans. He’s also pressuring the Fed to keep rates low, which is generally better for electability, and is also one of the reasons why the Fed’s independence and maintaining that is such an important thing. So rates are low. And then you also have the tail end of the Vietnam war, and war, unfortunately, tends to be great for economic productivity. And then you also have the oil embargo in 1973, and then another energy shortage in 1979, so prices are rising overall. And by 1980, the US inflation rate was at 14%. So what we’re seeing today is not what our parents experienced at the grocery store or in the housing market. And I think about that a lot.

Also, what we’re experiencing today is unlike other inflationary periods in that the market has been on a tear for the past few years. And with all of that, we have still had Keynesian monetary policy—low rates, the Fed stepping in—and that heated up inflation. And we just always have to remember that these things are a balance. This is the interesting thing about inflation, it sometimes seems to just spin up out of nothing, or so many factors that it’s hard to tease them apart. And calibrating when to respond, how severely to respond, is really quite difficult work. And that’s what we’re going to see the Fed figure out over the next few quarters.

Kira Bindrim: I’m just curious what the most fascinating thing you’ve learned about inflation is? So now I’m also at the grocery store with the person looking at the turkey. And I’m going to drop some knowledge on them share a fun fact with them about inflation while they’re staring at turkey. What is something interesting that I could let them know?

Other causes of inflation

Heather Landy: The things that we think cause inflation don’t always turn out to be the cause. So after the inflation of the 70s and 80s, the oil embargo and the Vietnam War were the two big culprits that people always pointed to. And that does make some logical sense that that would be the cause of it. But it turns out, when you strip those things out, inflation was still running really hot.

Kira Bindrim: Do you think inflation just becomes this distraction? Like I’m just thinking about how many bigger, non-cyclical things we need to solve—cough, cough, climate change—and all we’re talking about right now—not you and I, because we’re doing an episode—but all people are talking about in America is how prices are going up, and what are we going to do about prices, and who am I going to vote for based on what they promised me about prices? It just seems like a recipe to never deal with anything else. Am I too cynical?

Heather Landy: No, I wouldn’t say you’re too cynical. But I will say it’s been very heartening to me to see Governors of the Federal Reserve, for example, talking about this issue in the context of wage inequality, household wealth inequality. So if one of your broader goals for the economy is to have something that’s more inclusive and equalizing, then, you know, this is not a wasted debate to have, because the things that happen in terms of inflationary pressures and the ways that we respond to them are going to have real implications for either closing or widening things like wealth gaps. Of course, we’re going to be more obsessed with what’s happening in our own backyards and in our own grocery carts today. It’s natural. And I guess, the most important thing on that would be to make sure that the policies that we’re applying to that, and the people we are electing as a result, are still going to do the things that we want and need them to do.

Kira Bindrim: Okay, so there’s something sort of glass-half-full in there, that the conversation, the debate around inflation can ultimately affect some of the systemic issues that are important in all kinds of other ways. So I shouldn’t lose hope.

Heather Landy: Don’t lose hope.

Kira Bindrim: Thank you. Thank you, Heather, I learned so much, and now I have hope and things to think about at the grocery store.

Heather Landy: Excellent.

Kira Bindrim: That’s our Obsession for the week. This episode was produced by Katie Jane Fernelius. Our sound engineer is George Drake and our executive producer is Alex Ossola. The theme music is by Taka Yasuzawa and Alex Suguira. Special thanks to Heather Landy in New York.

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