Making sense of Inflation

If you took a look at the video we put up the other day, you’ll have noticed that the horizontal axis on that video represented GDP per capita, adjusted for inflation, and adjusted for purchasing power parity. What is inflation, and what is PPP? In today’s blog post, we’ll try and address the first question, and leave PPP for another day.

How much would you expect to earn if you walked out of a post-graduate college in India in the early 1970’s? About 300 rupees per month would have been considered par for the course back then.

How much would you expect to earn if you walked out of a post-graduate college in India about ten years ago? About 30,000 rupees per month would be a reasonable ballpark estimate.

Now, does this mean that a post-grad from 2007 was a hundred times better, or a hundred times more productive than a post-grad from 1977? Short answer: no.

Similarly, if a dosa back in the day retailed for maybe a rupee, and a dosa today sets you back by say fifty bucks – it doesn’t necessarily mean that a dosa today is fifty times better than a dosa from way back when.

In both of these cases, it’s not that the modern person or the modern dosa has gotten better – it’s that the purchasing power of the rupee has gone down. A rupee would buy you far more in the 1970’s than it does today.

Well ok, how much weaker is the rupee today? Now, the answer to that question can only be given by the measurement of inflation. Inflation, it turns out, is a way to compare different eras. But as any cricket fan will tell you, it is one thing to say something like this, and it is quite another to actually and definitively do it.

Who is the better batsman? Gavaskar, or Sachin or Kohli? Gavaskar, I would argue, faced the most hostile bowling of the three, while Kohli has to contend with the best fielding units among the three. Sachin lasted the longest of the three, and arguably had to contend with more expectations than the others – and this could go on and on. Since they played in different eras, comparing them makes no sense.

But an economist can’t just throw up her hands and say it can’t be done. She must devise ways and means to compare the purchasing power of the rupee across time. And this is devilishly difficult to do for many reasons, but here are the three most important ones:

1. The things you can buy with a rupee change dramatically over time. How many iPhones could a rupee purchase in 1970 is a stupid question, since there were no iPhones back then. You could purchase a laptop for 30,000 rupees in 2007 and you can purchase one for 30,000 rupees today. But they are simply not the same laptops. If you aren’t buying the same things, or if you are buying the same things, but of different quality, it makes measuring inflation much more difficult.
2. Let’s say the price of a particular metal goes up by 200% in a year, but hardly anybody uses this metal. The purchasing power of the rupee has gone down in this particular case, but that doesn’t mean everybody is now poor, since hardly anybody purchased that metal in the first place. But if the price of petrol goes up by 200% – ah, now that’s another story altogether. The prices of nearly every single thing change over time, but they don’t change at the same rate, and not all things are equally important. We must keep this in mind when we measure inflation
3. A teenaged girl living in a highrise apartment in Colaba is going to have a very different list of things she buys on a monthly basis compared to, say, a 60 year old landless laborer in a village in Chattisgarh. Not only are all things not equally important, but their importance changes based upon who is buying.

For these and many other reasons, trying to measure inflation is almost an exercise in impossibility. But then again, one can’t give up on it. Without some statistically acceptable way of measuring inflation, you simply wouldn’t be able to compare economic output (or GDP) across time.

Which is why measuring inflation is hard, but also important!