The business cycle

Mis-measuring inflation

By November 8, 2019June 11th, 2020No Comments

A recent article on Bloomberg reminds us that Eurozone inflation is probably underestimating the overall cost of living as it does not capture housing costs, which have been rising everywhere. This is a theme that ADA Economics has been flagging as a key source of the economic downturn since 2018 and a major challenge for central banks going forward. We actually believe that the problem is much bigger than just housing costs. Inflation rates, as measured today, do not capture the shortening usable life of items (faster programmed depreciation), nor the more complex pricing structures that are developing thanks to the increasingly widespread use of big data. Too much attention in the past two decades has been spent on the inadequate measurement of quality improvements of computers, which was legitimate and a dominant theme probably up to the 2008 global recession. However, since then, in our view, the much more powerful factor is the worsening quality of items, to nudge more frequent purchases. Inflation is most likely being underestimated everywhere, not just in the Eurozone. However, there is no simple or quick fix on the horizon, which suggests that central banks will continue to push for an exceptionally loose monetary policy going forward.

What should we do about this?

First, we should acknowledge the problem in full. The accelerated depreciation of an increasing number of items is not only a form of inflation, which thus affects the purchasing power of families, but also means a greater environmental impact.

ADA Economics has been advocating that there is a profound change taking place in the industrial landscape of Europe (in particular, but not exclusively), due to a powerful mix of persistently low interest rates, globalisation, and the current technological leap in big data and artificial intelligence. This trio disproportionally advantages large and ultra-large companies at the expenses of the micro-, small- and medium-sized ones, which are the backbone of every country. This mechanism, in our view, depresses the real GDP growth potential of countries and reduces the neutral level of the interest rate. There is no turnaround in sight, in our view. Accelerated depreciation is not exclusively a strategy open to large producers but, because of their size, the impact is felt more broadly.

In our view, the time has come for governments, which want to support and nourish their economies and their democracies, to re-think how to support their industrial sectors to restore, at least partially, a level playing field. Growth idea #1: power the national statistical office with greater monitoring and assessment capabilities on big data pricing and the evaluation of the average expected life of goods in the CPI basket.