Your Money Devalues Faster Than You Think

Source: Adobe / Tanu

Marshall Reinsdorf is a senior economist in the IMF Statistics Department (IMF) and past president of the International Association for Income and Wealth Research.
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Lockdowns, working from home, and physical distancing resulted in people spending more of their household budgets on food and housing, while fewer people buying non-essential items like plane tickets and clothing. And as incomes decline as millions have lost their jobs, spending on non-essential goods is likely to remain depressed.

The index of consumer prices (CPI) does not reflect these abrupt changes in spending patterns because the CPI weights are not continuously updated. For example, the CPI could be lowered by falling prices for unnecessary items that are no longer purchased.

A new IMF staff paper uses spending estimates derived from credit and debit card data to adjust CPI weights to reflect spending patterns during the pandemic. The study finds that inflation was actually higher than we thought during the first three months of the pandemic.

The chart of the week shows the difference between a COVID-19 price index that adjusts CPI weights based on the impact of COVID-19 on spending in Canada and an index with CPI weights unchanged over the February to May period. The diamonds in the graph show the difference between the two indices by region. In seven of the eight regions shown, the CPI is below the COVID-19 index. If one looks at the average of all regions together, the difference is 0.23 percentage points.

Undiscovered Inflation: Your Money Is Depreciating Faster Than You Think 102

The main positive contributors to the gap between the COVID-19 index and the CPI are food and transport, each adding 0.16 percentage points to the global gap. Rising food prices are contributing to faster growth in the COVID-19 index in all eight regions. Falling transport prices, which have a greater weight in the CPI than in the COVID-19 index, also contribute to the faster growth of the COVID-19 index in all regions except sub-Saharan Africa.

The main negative contributors to the global divide are residential property, contributing –0.03 percentage points and clothing, contributing –0.08 percentage points. Housing has a higher weight in the COVID-19 index than in the CPI, but its price index is so close to the overall CPI that increasing its weight does little to move the COVID-19 index away from the CPI. The downside effect of clothing is due to seasonal price increases with a lower weight in the COVID-19 basket.

Despite finding that CPI weights underestimated inflation in the early months of the pandemic, quickly updating CPI weights to reflect spending patterns during the pandemic would be impractical. In addition, the introduction of weights based on a short time frame can decrease the accuracy of an index in the longer term. A better approach would be for the statistical offices to develop an additional index, the weighting of which reflects the spending patterns during the pandemic. This would give policy makers a better picture of the impact inflation has on the prices consumers actually pay.
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This article was republished by blogs.imf.org.
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