Is inflation stuck in the past?

Is inflation stuck in the past?

• There are two ways in which consumer price inflation is influenced by the past rather than the present.

• The year-on-year inflation rate says as much about prices a year ago as it does about prices today. Today’s inflation is comparing price levels in a locked down economy with a normalized economy. That is a problem as prices in a locked down economy were abnormally low, and the calculation relied heavily on guesswork in some sectors.

• The consumer price basket of goods is created using past spending habits. Normally this does not matter, as spending habits typically do not change that much. But the pandemic and the energy price shock have both led to dramatic changes in what we buy. For instance, European inflation numbers assume people are spending like the economy is still in lockdown (this underweights service sector spending). Changing patterns of consumption from the energy price rise are also ignored—if consumers switch to discount stores, or own-label rather than branded products to save money, their expenses could fall, but consumer price inflation will not recognize this is happening.

• The backwards-looking nature of inflation means that while prices have obviously risen, consumer spending power may be a little bit stronger than consumer price inflation suggests.

  Paul Donavon, Chief Economist

  UBS