Friday 2 September 2011

How 'real' are real (vs nominal) prices/wages?

Whichever economist decided to call inflation-adjusted price and wage figures 'real' values had a real bad idea. It's a bit like calling an era 'modern' - what do you call your next degree of refinement?

I recently listened to a debate on the American economy where much was made of whether the average 'real' wage had increased since the seventies, and also watched a video by one of the participants (Horwitz) where he discusses cost of living; allowing for inflation (or change in average industrial wage); and the difficulty that the underlying products being priced change radically over time. Horwitz focuses on how the car you buy today is wildly different than a car from 80 years ago, so for only a few more hours of labour you can buy a much more useful car.

The next day I read this book review which quotes Christopher B. Leinberger's calculation that the need to buy a car adds about $135,000 to the effective cost of the average suburban house (in 2005 America). How do you factor that into your inflation calculation? You get more benefit, but you are also more dependent. I believe this is meant to be accounted for by the scope of the basket of goods used to calculate inflation, but the number of estimates and approximations starts to make the mind reel.

ps. If you're wondering what the 'nominal' prices/wages mentioned in my title are, they are just the actual dollar values spent/earned at the time of spending/earning; the original numbers before any adjustment.

Also, hat tip to Chris Blattman for putting me onto the blog where I found Horwitz, which I hope will give me some 'Austrian' economist perspectives that I have lacked exposure to thus far.

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