Getting the Measure of Money: A Critical Assessment of UK Monetary Indicators by Anthony J. Evans;

Author:Anthony J. Evans;
Language: eng
Format: epub
Publisher: Book Network Int'l Limited trading as NBN International (NBNi)
Published: 2018-12-17T13:32:20+00:00

Price indices

The costs of looking at the wrong price index are severe. One of the biggest policy mistakes of the twentieth century was when Britain returned to the gold standard at the pre-war parity. Keynes’s explanation for why this happened was that Churchill was ‘gravely misled by his experts’ (Keynes 1963: 249), who used a wholesale price index to make a comparison with America. Such an index largely comprises widely tradable raw materials, which are relatively flexible. As Alchian and Klein (1973: 185) point out, this ‘significantly underestimated the extent of the necessary deflation’ – the money wages of dockers in Liverpool are a lot stickier, for example. An obvious way to mitigate some of the costs of inflation is to use index-linked contracts. However, these don’t fully solve the problem. A reason for the rarity of index-linked contracts is that any individual price index is an imperfect measure of what any individual person wants to protect themselves from. Indeed, ‘the fact people don’t use price indices for long term contracts more, suggests concerns about such indices being good measures of what actually happens to “the price level” ’ (ibid.).

The two traditional methods of measuring the price of baskets of goods over time are a Laspeyres index and a Paasche index. The former uses the initial quantities and thus tends to be biased upwards since consumers would be expected to switch to lower-priced goods. By contrast, a Paasche index utilises subsequent quantities, but as a result tends to take longer to compile. As Selgin (1988) points out, there are three issues that need to be addressed when constructing a price index: the choice of goods and services to include in the basket, the measure of central tendency (this is necessary in order to summarise the basket in a single figure) and the weights assigned to each item. These are the ‘practical difficulties that frustrate construction of a reliable price index’ (ibid.: 97).

All of these choices are somewhat arbitrary and all of them likely to change over time. Arthur Marget (1942: 33) used the term ‘swarm’ to capture the way in which prices change in an economy, and argued that unless most prices were changing by the average amount, an index would be misleading (see Egger 1995: 15). This addresses an important difference between how monetarists and Austrian school economists approach inflation. Whereas the former are concerned more about an index displaying a large average, the latter are more worried about the variance (of the individual prices).

It is well known that policymakers can tamper with official statistics. The term ‘suppressed inflation’ refers to the practice of masking a fall in the value of money by altering the method by which inflation measures are compiled (McCulloch 1975: 36–39). This isn’t the claim being made here, however. And the points that follow are not criticisms of price indices per se. They are a combination of several different problems that specifically affected the CPI in the years leading up to the financial crisis. Taken

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