How the virus disrupted inflation statistics

The seismic economic disruption of the pandemic has led to a sudden and drastic change in consumer spending patterns around the world, leaving official inflation data unrelated to what they are going through.

Surges in price growth in many major economies are worrying investors and central bankers. But part of this trend can be blamed COVID-19 With important consequences for how we interpret official data.

Inflation is measured using a basket of goods and services that are meant to represent what people usually buy. Items are given weights proportional to the amount spent on them.

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Day 1: Advanced economies have not faced a rapid rise in inflation in decades. Is this about to change?

Day 2: Global consensus among central bankers on how best to promote low and stable inflation I broke down.

Day Three: The Canary in the Coal Mine for US Inflation: used cars.

Day 4: How the virus can disrupt official inflation statistics.

Day 5: Why high prices in advanced economies are a problem for heavily indebted developing countries.

Across the world over the past year as the pandemic has spread, people have stopped spending on restaurants, airline tickets and other activities restricted by the overnight shutdown.

As a result, the experience of some countries in the real world economic inflation It differed from the main official average by as much as 0.89 percentage points in one month last summer, according to research by Harvard professor Alberto Cavallo. US inflation may have been underestimated by 5.5 percentage points over the course of 2020, Cavallo estimates..

The turmoil is set to continue as major economies return to normal consumption patterns, economists warned – making it difficult to explain the official price-change actions that are central banks’ primary policy goal.

The details of US and Eurozone inflation calculations differ, but both methods lead to the same challenge.

US accounts mismatch

The US Bureau of Labor Statistics uses survey data that lags behind real-world changes by two years. So since the pandemic began, official inflation data has been calculated using weights that reflect the pre-pandemic world.

Measurement error is particularly severe in two categories.

A line chart of the percentage change in credit and debit card spending showing that the closures forced significant changes in spending patterns in the United States

Grocery spending increased 29 percent in March of last year according to credit and debit card purchase data from Opportunity Insights. The increase in demand drove prices up by 2.7 percent on a monthly basis.

In contrast, spending on transportation fell 70 percent in April of last year, and prices are down 7 percent since the beginning of the year. The effect persisted: spending on transportation remained 25 per cent below pre-pandemic levels in May of this year.

According to economists, the net effect is that the official calculation of the consumer price index has underestimated the price changes experienced by the population in their daily lives.

“You can easily see why the CPI was such a poor gauge of inflation during the pandemic recession,” said Miguel Faria e Castro, an economist at the Federal Reserve Bank of St. Louis. “This stagnation has led to an unprecedented shift in the composition of household consumption.”

Such as US economy Opens and closes ends, the effect is reversed.

For example, the decline in the production of cars and trucks over the past year has driven up the prices of used cars. Since Americans have spent less on transportation since the start of the pandemic than the CPI weighting suggests, the official April inflation reading – which I made a big leap – Maybe it was an overestimation.

Line graph % shows that official US CPI underestimated inflation during the pandemic

“In April, a third of the jump was caused by used cars and trucks. This has been a big driver of this,” said Cavallo, who used real-time spending data from Opportunity Insights to reweight items in the CPI basket to more accurately reflect recent price changes. .

“The CPI basket should have weighed less [transport], And the [then] You get a lower reading for inflation in the month of April.

European reset problem

Unlike the US, the Eurozone inflation weighting is updated annually in January. Changes in consumption patterns during the pandemic mean that this year’s accounts will not give much weight to the prices of items such as gasoline, hotels and restaurants, which were hit by the lockdown last year.

Line chart of weights (from 1,000), selected items showing unprecedented changes in some eurozone inflation weights

As a result, even if European consumers return to their pre-pandemic spending patterns as the economy returns to normal, official statistics will reduce spending in these areas.

“Interpreting this year’s inflation data will not be an easy task” because pandemic-era spending creates distortions not only during lockdowns “but also later this year with the [consumers] return to normal consumption patterns.”

This means that the official inflation statistics are “less accurate,” says Gregory Claes of the Bruegel economic think tank. “We’re going to have the same problem we had last year, but we’re going back,” he warned.

The effect can be significant. For example, the weighting of recreation, personal services, restaurants and hotels decreased by 40 and 30 basis points, respectively, in 2021 compared to the previous year. On average over the past 24 years, these areas of spending have changed by only 0.6 basis points per year.

The issue is already clear in the case of gasoline: both price and consumption have fallen in size last year. Gasoline prices are now rising again, but their impact on overall inflation will be 13 percent lower than last year – and that effect will continue until the eurozone inflation basket is reset again in January. The same trend can happen with hotels and cinemas.

Bar chart of Eurozone inflation in January 2021, computed using two different weights (annual % change) showing the change in weighting pushed Eurozone inflation higher

European Central Bank calculated That the inflation experienced by consumers last year was 0.2 percentage points higher than the official CPI between April and August, and the weights changed this year Push the inflation rate up by 0.3 percentage point in January.

Policy makers “will need to write this down and test alternative measurement methods to get a better understanding of actual inflation dynamics” – as these statistical gaps continue to wreak havoc on CPI in the coming months, Katharina Utermole, chief economist at Allianz, said.

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