Slate Article on Measuring Inflation
A recent Slate article by the Underground Economist Tim Harford does a good job of explaining why it's so hard to measure inflation:
But which increasing prices? Flipping through the Montgomery Ward mail-order catalog, which began publication in 1893, economic historian J. Bradford DeLong calculates that a simple bicycle cost 260 hours' wages for the typical worker in 1895 and just 7.2 hours' wages in 2000. But silver spoons actually cost more hours of labor today than in 1895. Your personal inflation rate depends on whether you are spending your money on bicycles or spoons.
The official inflation rate tries to compare the price of a typical bundle of goods today with that of a typical bundle of goods in the past. But we do not consume the same goods today as we did in the past. How many Walkmans in an iPod? The question has no sensible answer, but an answer, nevertheless, is codified in the official inflation rate.
You can be forgiven for thinking that this is an irrelevant intellectual game. You will not, of course, be thinking that if your pension or salary is linked to the inflation rate.
In recent years, received wisdom among economists has been that the inflation rate has been overstated because of unmeasured improvements in quality. Home computers have not only become cheaper but dramatically better, and failure to fully adjust for the quality improvements would overestimate the inflation rate and underestimate how much better off we are compared with previous generations.
If it's true that we've been overstating the inflation rate all these years, it follows that we are much better off in real terms compared to our forebears. But that doesn't make sense either. As Harford notes, economist Robert Gordon figures that if recent estimates of inflation bias are correct, then a peasant household in the mid-16th century would have had an annual income of only $6.