Economic Perspective: Inflation and Product Quality

MARY WALDEN:

“Today’s program looks at inflation and product quality. Mike, although the reported inflation rate has been very low recently, many people are suspicious of this number. They wonder if all products and services are included in the measure, and they also hear about things like hedonic adjustments to prices. Should we trust the reported inflation numbers?”

MIKE WALDEN:

“Just the other day I gave a talk, and one of the questions I had when I was talking about inflation was a gentleman said, ‘Well what about these hedonic adjustments? Aren’t they fake? Don’t they really make the inflation rate lower than it actually is?’ So let me explain what’s going in the measurement of inflation.”

“First of all, there are measures of inflation that restrict the prices of particular products in there. For example, food and fuel sometimes are left out. The inflation numbers I quote are inclusive of all those. And then this matter of hedonic adjustments. That’s just a big, fancy term for adjusting for quality features of a product.”

“For example, what if we’re tracking the price of vehicles. And what if, for example, you go back a few years ago, GPS features were added. That’s obviously going to increase the price of a vehicles, but we wouldn’t want to say that’s inflation because that’s a new feature. That’s making the new vehicles be able to do things, find directions, et cetera, better. So the hedonic situation, the hedonic adjustment if you will, is a technique that goes through products like vehicles, and says if there’s any quality adjustments we’re going to back out the additional cost of those.”

“So the government, I think, does a very good job of tracking inflation, and I think one check on the government is there are lots of private estimates of inflation. And what you find is those tend to be very, very close to what the government finds.”

Mike Walden is a William Neal Reynolds Distinguished Professor in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook and public policy.