From the archives: Where inflation comes from
How we calculate inflation has always been contested with small changes leading to large differences in how well-off we think we are.
Carola Conces Binder writes about the history of trying to measure inflation, for Issue 16. Read it on our website here.
Every month, the US Bureau of Labor Statistics releases its newest data on the consumer price index (CPI). The CPI report is eagerly awaited by economists and policy wonks and investors. It garners heavy news coverage as a key piece of information in macroeconomic policymaking and analysis. The CPI and related measures affect monetary and fiscal policymaking and are often used to adjust Social Security payments, income tax brackets, and wages for millions of workers. Because of these far-reaching impacts, even relatively small changes in the measurement of the CPI can have major implications for households, firms, and the government’s budget. Thus, the technocratic task of measuring the price level is often at the center of political controversies. The evolution of inflation measurement in the United States has reflected both technical progress and these political forces.
The government’s role in the collection and publication of price indexes has been politically controversial from its origins, which were surprisingly late. Wesley Clair Mitchell, the former president of the American Economic Association, in 1921 called it:
a curious fact that men did not attempt to measure changes in the level of prices until after they had learned to measure such subtle things as the weight of the atmosphere, the velocity of sound, fluctuations of temperature, and the precession of the equinoxes . . . Perhaps disinclination on the part of ‘natural philosophers’ to soil their hands with such vulgar subjects as the prices of provisions was partly responsible for the delay.
The first known price index was constructed by Count Gian Rinaldo Carli, an Italian professor and polymath, in 1764. Prices in Europe had been spiraling upward since the opening of trade with the New World. This ‘Price Revolution’, most notable in Spain and its neighbors, occurred with the inflow of large amounts of gold and silver. In Italy, many observers thought that prices were rising because Italy was getting richer as a result of accumulating gold from trade. To facilitate his study of rising prices, Count Carli collected prices of grain, wine, and oil from around 1450 and also from around 1755. For each commodity, he computed the percent change in price from the earlier to the more recent period. Then he took a simple average of those three percentage changes. This served as a basic measure of commodity price inflation. He did this using prices in terms of the Italian legal tender (lire), and then using prices in terms of gold and silver bullion. Prices in terms of lire had increased sharply, while those in terms of bullion rose only slightly. He concluded, therefore, that rising prices had resulted from the Italian government’s frequent debasement of the currency, rather than from growing wealth.
Governments around the world did not rush to adopt Carli’s methodology. Adoption came later, often driven by pressing circumstances. In the United States, one catalyst was the Civil War. To finance the war, beginning with the passage of the Legal Tender Act of 1862, the Union government began issuing paper money called greenbacks, unbacked by gold or silver. The greenbacks were the center of an intense debate about the constitutionality of paper money and the likelihood that it would lead to severe inflation. As the war progressed, Treasury Secretary Salmon Chase published rudimentary price indexes to demonstrate that, while high – prices roughly doubled during the war – inflation was not as bad as some feared.
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