Innovation-Driven Dis-Inflation Distorts Perceptions of the Economy

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Innovation-Driven Dis-Inflation Distorts Perceptions of the Economy

On the central economic questions of inflation, productivity, and income growth, our perceptions are largely dependent on our ability to measure them.  Lots of smart people do great work collecting and analyzing data on prices and wages.  However, the world seems to be changing faster than our ability to accurately measure it.

The U.S. government frequently adjusts prices of goods to account for changes in quality.  However, these so-called “hedonic adjustments” are very difficult to estimate and are only done in a handful of areas.  So, while these adjustments to statistics have had a small aggregate impact on reported results, real-world experience suggests that there have been massive improvements in quality and value via innovation that isn’t reflected in the metrics

 Consider some new research by Austan Goolsbee and Peter Klenow, which bolsters the idea that the economic data don’t fully capture the benefits of the digital economy.  Based on new data from Adobe Analytics for millions of products, Goolsbee and Klenow show that e-commerce significantly lowers prices.

They estimate that online inflation was about 1 percentage point lower than in the CPI for the same categories from 2014-to-2017. In addition, the rising variety of products sold online implies roughly 2 percentage points lower inflation than in a matching CPI-style model index.

Writing in The Wall Street Journal, tech investor Andy Kessler is even more critical of our measuring abilities.  In fact, he thinks the government’s price and wage estimates are close to worthless.  Kessler acknowledges efforts to account for technological and quality improvements through “hedonic adjustments” but thinks they don’t come close to capturing true advances. He suggests the following thought experiment: 

“Think about your car’s automatic emergency braking, sometimes known as pre-crash or collision avoidance.  It has been an increasingly popular option in recent years.  By 2022, it will be standard on most cars.  [It consists of] some silicon sensors and a few pieces of code — today it costs maybe $50 to produce. But what’s it worth?”

“Let’s do a little hedonic decomposing of our own. Before these sensors, you would have had to hire a person to ride shotgun and constantly watch for potential collisions and slam on the brakes for you...

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