Wednesday, August 17, 2005

Stop Adjusting for Inflation

The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.
Ernest Hemingway (1899–1961), author

Economy Shows Signs of Strain From Oil Prices reads a front page headline on the New York Times website. What a surprise!

The article says Wal-Mart blames energy prices for not meeting quarterly profits. Airlines are again feeling the pinch, and the winter fuel needs have yet to come into play.

Here is my favor line: Without question, economists say, rising oil prices cause less economic pain than they once did. It takes half as much energy to produce $1 of gross domestic product today, adjusted for inflation, than it did 30 years ago. Even at today's prices, oil is cheaper than it was in the early 1980's, once adjusted for inflation.

It does not seem that we should compare products based on an adjusted for inflation index unless everything is based similarly. We can’t adjust our pay checks for inflation. Adjust my home for inflation and it’s worth $2 million, but you say my home value is current. So are the gas prices. They have not stayed stagnant. My salary is current, adjust it for inflation and I should be making something akin to a poor mid-level executive. Adjusted for inflation seems a bogus yard stick.

9 comments:

Guerilla Gorilla said...

Guerilla Gorilla convinced mate of virility by telling to "adjust for inflation." [grunt]

Anonymous said...
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Jesse said...
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Jesse said...
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Jesse said...

Actually, your salary has already been naturally adjusted by inflation (that's the whole thing with inflation). Old prices, though, must be adjusted manually to be comparable. Current prices reflect a change in scarcity of resources combined with the effect of inflation over x years. Old prices reflect scarcity at the time, but do not include the effect of inflation over the years to the date of comparison.

The Misanthrope said...

I disagree, but not vehemently, since I am treading into territory that I barely understand. My salary is not adjusted for inflation. If I receive an increase it's for merit (supposedly), not for inflation which would be a separate increase.

If you look at what my salary would have purchased say in 1980, which is what they compare gas prices to, I would be making so much more. Gas prices have not stayed stagnant for 20 years, which is why it seems odd to say compared to 1980 gas prices are still cheap.

Steven Taylor said...

Well, actually, your salary is adjusted for inflation--to see this just compare what someone doing your job was making in 1980 and you will see that the same person, with the same job, experience and training made substantially less than you make now.

In regards to raises and merit--at least part of every raise helps a person keep pace of inflation. If the inflation rate is 2.5% and you get a 2.5% raise, all you have gotten is a cost of living increase--not a real raise because all that has happened is that you purchasing power has remained in check with the cost of goods. If you get a 10% raise, however, you have truly increased your purchasing power.

One of the reason that long-term mortgages are great if you stay in the same house is that your monthly payment is protected against inflation (and other price pressures) over the life of the loan. This is to be counterposed with rent, which has not such protections. (And again, that's not all inflation, but it is part of it).

You absolutely have to adjust for inflation to understand the relative significance of the cost of items over time. A dollar in 1970 is not a dollar in 1980.

It is wholly possible for an item to cost more in today's dollars, but actually be cheaper in real terms.

Paying a 1.80 for gas in the early 1980s was a bigger burdern than paying 2.50 is today. (Not that I like paying 2.50--I live 38 miles from work and my kids just starting going to school on the other side of town).

Just think back what movies, a soda, hamburgers, or toys cost when you were a kid verses now

The Misanthrope said...

Thank you. There is a reason that they call economics the dismal science.

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