Wednesday, November 28, 2007

The Zimbabwe CPI is now Undefined....

According to this article, the Zimbabwe state statistical agency is no longer calculating the CPI, as there are too many empty shelves, and not enough goods left to include in the calculation.

Following from my earlier discussions of Zimbabwe's inflation (the latest being here), I think this new development highlights a potential bias in the CPI that I haven't seen discussed elsewhere. What is the price of a good that is no longer available at any price? The only answer to this question is that it is undefined, or infinite. If even one component of the CPI is no longer available at any price, then regardless of how trivial that component is within the CPI, Zimbabwe inflation now equals infinity!

(This is part of the reason why price controls are such a bad idea: they lower the prices for some consumers but inevitably create shortages, and therefore infinite prices, for others).

But life is not actually quite as bad as infinite inflation would imply. Recall that we often use the CPI as a measure of the "cost of living." To an economist, the cost of living is the lowest cost of attaining a given standard of living, or utility. The CPI is an imperfect measure of this because it ignores substitution effects (consumers substitute away from relatively expensive goods towards cheaper ones), new goods (the weights are only updated occasionally, so ignores the rapid price declines usually associated with new goods), and improvements in quality over time. These three biases tend to result in the CPI overstating rises in the true cost of living.

If we ignore goods that are no longer available at any price due to a collapsing, corrupt, crime-ridden economy, then that introduces a bias that works the other way. It will not in fact result in infinite inflation (since a rational consumer would substitute away from the unavailable goods to those that are still available), but in the case of Zimbabwe is likely to result in measured inflation significantly understating the true rise in the cost of living. True infinite inflation can only arise when there is nothing left available for sale at any price.

So the poor people of Zimbabwe who have been arguing that the prices they pay are rising faster than official CPI figures indicate have a point.

And what is the source of this hyper-inflation? The money supply is growing at 18000% per year! as Friedman said, "Inflation is always and everywhere a monetary phenomena."


Bret said...

Greetings -

This is Bret from the United States. I am doing a paper for college titled "Zimbabwe Inflation: Could It Happen Here?"

I want to learn:
Why Zimbabwe became hyper-inflated
When was the no-going-back point?
Were there any signs in society (such as a marked increase of debauchery on TV) just before the no-going-back point?

After all is said and done, how is life in Zimbabwe different for the average person today than it was 10 years ago? I imagine the rich folks dodged the crises by cutting their spending, and converting their money to stronger currency, but what about the labor force? In other words, do the rich have to wash their own cars now because they can't afford to hire someone to do it for them? Do the regular folks have to settle for basic cable instead of getting HBO and the other movie channels? Do kids of regular families even go to school? What do the teens do on Friday nights?

Is Zimbabwe a tribal nation? Or has it become westernized? If it is not westernized, can we even compare inflation rates? Does the concept of money not even apply in Zimbabwe, in other words, do regular people normally barter for trade?

I want to compare these signs to those in the US.

I heard that the US is in bad shape economically, but when I ask, people seem to think that we are immune to big problems such as those of 3rd world countries. I don't believe we are. I am trying to show this in my paper.

Thank you so much for your consideration. Please write soon.

Your friend,
Bret Leduc

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