Here is what happens when number crunchers stop believing in numbers and start worrying about themselves. The inflation numbers look good. The Consumer Price Index rose just 0.1 percent in May and just 2.5 percent during the year before. The Federal Reserve believes it has tamed inflation with a series of measured interest-rate increases.
But many professional analysts refuse to believe. As a group, economists surveyed by the Wall Street Journal forecast that inflation will pick up pace in coming months. In June, for example, Brian Wesbury of Griffin, Kubik, Stephens & Thompson projected inflation would "rise to the 3.5 percent to 4.0 percent range during the next 17 months."
Why are the dismal scientists skeptical? After 18 years, they have lost some of their enthusiasm for Greenspan. Others wonder how inflation can be so muted when the prices of energy, housing, and short-term borrowing have risen so dramatically in the past year. And there's a growing sense that we can't trust the government numbers. For example, because the government only calculates housing costs as rents—not as the cost of purchasing homes—the boom in the home-purchase market may have had the strange effect of tamping down the CPI.
But something else could be at work here. Economists are supposed to be rational creatures, coolly examining numbers. Intuitively, they know that anecdotal evidence is just that. But Goldman Sachs economist Avinash Kaza suggests economists are being influenced on where they stand on inflation by where they sit—geographically, professionally, and on the income ladder. It's a variant of what Spy magazine once dubbed "personal-injury journalism," the process by which stories that directly affect editors become trend stories. Call it personal-injury economics.
Kaza set out his theory in a June 2 market comment that Barron's mentioned last weekend. The document isn't accessible to non-Goldman clients, although Kaza was kind enough to share it with Slate.In it, Kaza attributes the perception that inflation is being undermeasured to groupthink. The economists who make forecasts on inflation tend to be concentrated in and around New York; Washington, D.C.; Boston; Los Angeles; and San Francisco. They tend to be well-off and associate and work with other well-off people.
And that's the problem. The national CPI figures smooth out a great deal of regional variation. Inflation can rise in one part of the country as it falls elsewhere. And depending on how much you make—and hence how much you spend—your experience with inflation can also vary greatly. If anyone is likely to be suffering from inflation now, it's rich people in New York and other large cities.
Back in February, Jennifer Steinhauer noted in the New York Times that New York leads the nation in inflation. Between January 2004 and January 2005, New York's CPI rose 4.1 percent—compared with a 3 percent increase nationwide. The trend of urban inflation has continued—and not just in New York. Kaza crunched the numbers, comparing the top 10 metropolitan areas with the United States overall. In March, New York's inflation rose at a 4.2 percent annual rate, compared with 3.1 percent for the U.S. In Los Angeles, inflation was even more rampant: 4.8 percent. In Washington, it was 3.5 percent. As a result, people living in New York or other large cities are likely to experience higher inflation. What's more, water-cooler conversation about the rising price of housing and taxis is likely to contribute to a mindset that inflation is on the rise.
That's only half the story. Kaza notes that different consumers within the same geographic regions experience different levels of inflation. For Wal-Mart shoppers, the company's ability to source products cheaply in China means it can hold the line on prices. Translation: Lower-income shoppers may not encounter much inflation in the aisles of the nations' largest retailer.
For the elites, however, it's a different story. Thanks to the tax cuts and growing income inequality, the rich today have more money to spend. As a result, competition for the goods they like to buy—homes on Nantucket, fine art—drives up prices. And these folks never set foot in Wal-Mart. They shop at Bergdorf Goodman, Whole Foods, and Manhattan Motorcars. And thanks to a combination of consumer demand and the weak dollar, the price of a lot of the goods sold in these places has been rising. Kaza notes that Forbes' Cost of Living Extremely Well Index, which tallies the rise in costs of items such as Gucci loafers, Harvard tuition, caviar, and Steinway pianos, has been rising far more rapidly than the consumer price index in recent years. (Forbes supplies a handy chart showing the decoupling of the CLEWI from the CPI.) "Globalization has not really affected the pricing power of luxury goods, which are differentiated products and not as susceptible to lower-priced competition," Kaza notes. If you're buying Châteauneuf du Pape at Sherry-Lehmann instead of Budweiser at 7-Eleven, it sure seems like the cost of necessities has risen sharply in recent years.
Kaza, who believes the government is measuring inflation more or less accurately, makes an intriguing argument. There are questions it doesn't answer. The cost of living in Manhattan—and of luxury goods—has been rising for a long time, so why have concerns over runaway inflation arisen only recently? Also, how to explain that the costs of many of the things that rich people like to buy (computers, plasma televisions, fractional jet ownership, cell phone service, laser eye surgery) have been dropping?
Still, the case for groupthink and conflating personal experience into macro-trends—two no-nos for economists—is convincing. And there's another factor at work here. In New York in particular, price increases in trademark goods are well-documented in the media: subway fares, Broadway tickets, even fish. And rising home prices, of course, have been the singular New York obsession for several years.
So, let's not envy the rich. They deserve our pity. Sure, their dollars may be more lightly taxed than they were a few years ago. But they don't go nearly as far as they used to.
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