Bananaman lives in Barterland. Bananaman grows bananas for a living, and often travels to the Barterland market where he swaps his bananas for other goods.
Bananaman is clever. He suspects that the Barterlandians are slowly thinking less and less of his bananas, but he's not quite sure, because many of the other goods are seasonal as well, so there is rarely any consistency between the number of apples or oranges that he gets for his bananas, but lately he's feeling as though he's just not getting as many swapped goods as he used to.
Bananaman is really clever. He devises a scheme, whereby he creates a basket of goods that he likes, including apples and oranges and other juicy things, and over time, he'll track how many bananas he has to swap to get the goods that he likes.
He realises that 2 things are very important. Firstly, it is important to ensure that the basket has a fairly diverse set of goods, to flatten any variation in value of the individual goods in the basket. Secondly, it's very important that the contents of the basket says exactly the same every time, as this allows him to compare the results, like for like, over a long period of time.
Bananaman does this over a number of years, and plots the graph of the results. He was right. The number of bananas required to purchase the same basket of goods is slowly increasing over time. He says to himself - "I was right - the value of my bananas is slowly falling over time - and so I'm needing to use more and more bananas over time to buy the same basket of goods".
Bananaman is smart. Notice that he didn't say "The value of every thing except my bananas is going up".
Clearly, the point of isolating a single item outside of the basket was to determine if that item is rising or falling in value, not whether the basket is rising or falling in value.
So, why the heck, when we measure the CPI using a basket of goods, and leave the AUD (or your given currency) outside of the basket, do we say the "the price of the basket is rising" instead of "the value of the dollar is falling"?
Subscribe To
Posts
Comments
I wish you hadn't used bananas as the example.
ReplyDeleteWe measure CPI by the cost of a 'basket of typical goods'. But when a cyclone wipes out the banana plants and causes bananas to hit $15/kg the price of the basket jumps. Except that this is not a true measure of CPI because people then buy less bananas. But then because bananas are no longer as popular, the basket which is the 'typical' consumer basket changes (it now contains less bananas). But then, then new banana plants grow, and bananas get cheap again the cost of the 'typical' basket drops, but not as much as it went up when the banana price rose (because it now contains less bananas).
What's the fix for this? Well we could, as you suggest, keep the basket the same but this doesn't work. Should the basket still contain buggy whips, typewriters or VCRs in 2011?
Apparently (according to a Treasury source) this is a real problem which causes the official inflation figures to be overstated.
We seek complexity .. :)
There are no cyclones in Barterland. :-)
ReplyDeleteAlthough the issues you present are real, I don't think that they are prohibitive.
The bigger issue that I see are:
1) Why don't we report that the AUD (or whatever currency) has fallen by 3.1% in comparison to the basket, rather than report CPI inflation of 3.1%, and
2) Why do the "dollar indexes" compare 1 currency against a basket of other (fiat) currencies, rather than against a more stable basket? It's like 10 men jumping out of an airplane, and the Aussie falling slightly slower than all the others, and the cameraman - also falling - announces "Look, the Aussie is rising".
First thing that came to my mind was "Newton vs Einstein". In Barterland, you describe a system where values are all relative, but CPI appears to assume a Newtonian-like model with fixed reference points.
ReplyDeleteIf something like special relativity applies to economics, then it's not surprising that CPI could be misleading as it's built on a model that is incorrect.
Newtonian physics are a useful approximation at non-relativistic velocities, but for "large values", Newton's forumulae break down. Perhaps the same applies to micro-vs-macro economics?
Surely I'm not the first to follow this train of thought.
I'm not suggesting that CPI is built on a model that's not correct. Simply, that its common usage leads people to believe that the value of the basket is changing over time, whereas logically, it is the value of the item that is left out of the basket that changes in value over time.
ReplyDeleteI'd have to scratch me head a few more times before I can see any useful parallels between relativity theory and relative values of things..