Inflation is an issue that i frequently encounter while studying the macros of a number of economies. Almost everybody - from a layman to a policy maker to a corporate body - is interested in this number. Critical investment decisions worth billions of dollars are to some extent dependent on this number.
What however intrigues me is how come inflation numbers published by central banks or other institutions for the whole economy are relevant for a micro unit (household, or business unit) of an economy?
I understand that these broad numbers are very relevant for policy makers wanting to understand the direction in which the economy is going and what tightening or loosening it needs. I also understand that each country defines a number of inflation categories (consumer, producer, housing, labor etc.) to show the broad price trends in each of these categories.
My contention however is that there is need for a "personalized inflation" number for every decision maker. This number would be based on the exact consumption pattern of the economic unit under consideration. And the reason this needs to be considered is that broad inflation numbers ignore the concept and possibility of "substitutability" in consumption.
Let me illustrate this with some examples. At a household level when the price of a particular food item rises one either substitutes it or changes the consumption habits to spend more on that food item. So if ladyfinger becomes expensive you consume more of say pumpkin. If the price of onion (relatively inelastic), however, rises one might have to reduce the number of times one goes to the cinema.
The level of well-being in such times of inflation depends on substitutability options. The poor man has limited substitutability options and therefore he is impacted more but even this limited substitutability in most cases is good enough for survival.
At the level of business units again the consumption baskets and patterns of each unit is different and the broad inflation measure doesn't readily apply. The inflation for a distributor would be different when compared to the inflation for a manufacturer. The inflation in pharma industry would be different from the inflation in the technology industry or the construction industry. At the same time the options of substitution would be quite different for each player.
If the data collection bodies in each country could therefore provide a dynamic inflation calculator to the economic units (something on the lines of say a loan EMI calculator) it would be more useful. In such a calculator the economic unit would pick its own unique consumption basket and get the results. It could also allow for better decision making by allowing different permutations and combinations of consumption items.
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January 18, 2012
I realize that my thought of 'personalized inflation' is not that unique actually. UK's ONS in fact provides a link that allows a family to calculate personalized inflation. Once you feed in your expenditures across various categories the tool calculates and compares your inflation to the national inflation as shown in the figure below.
What however intrigues me is how come inflation numbers published by central banks or other institutions for the whole economy are relevant for a micro unit (household, or business unit) of an economy?
I understand that these broad numbers are very relevant for policy makers wanting to understand the direction in which the economy is going and what tightening or loosening it needs. I also understand that each country defines a number of inflation categories (consumer, producer, housing, labor etc.) to show the broad price trends in each of these categories.
My contention however is that there is need for a "personalized inflation" number for every decision maker. This number would be based on the exact consumption pattern of the economic unit under consideration. And the reason this needs to be considered is that broad inflation numbers ignore the concept and possibility of "substitutability" in consumption.
Let me illustrate this with some examples. At a household level when the price of a particular food item rises one either substitutes it or changes the consumption habits to spend more on that food item. So if ladyfinger becomes expensive you consume more of say pumpkin. If the price of onion (relatively inelastic), however, rises one might have to reduce the number of times one goes to the cinema.
The level of well-being in such times of inflation depends on substitutability options. The poor man has limited substitutability options and therefore he is impacted more but even this limited substitutability in most cases is good enough for survival.
At the level of business units again the consumption baskets and patterns of each unit is different and the broad inflation measure doesn't readily apply. The inflation for a distributor would be different when compared to the inflation for a manufacturer. The inflation in pharma industry would be different from the inflation in the technology industry or the construction industry. At the same time the options of substitution would be quite different for each player.
If the data collection bodies in each country could therefore provide a dynamic inflation calculator to the economic units (something on the lines of say a loan EMI calculator) it would be more useful. In such a calculator the economic unit would pick its own unique consumption basket and get the results. It could also allow for better decision making by allowing different permutations and combinations of consumption items.
....................
January 18, 2012
I realize that my thought of 'personalized inflation' is not that unique actually. UK's ONS in fact provides a link that allows a family to calculate personalized inflation. Once you feed in your expenditures across various categories the tool calculates and compares your inflation to the national inflation as shown in the figure below.
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