How inflation gets measured (pretty crazy 🤯)

This is The Level Ups. The free, newsletter with useful business insight (explained like your friend, not your prof).

Today we cover:

• What is Inflation

• Why does it matter

• How does it actually get measured?

• The controversy

Let's get into it.

Estimated reading time: 3 minutes & 28 seconds

You've heard of inflation. But what is it really?

Inflation is how the value of a dollar changes over time. For example, $100 today buys you 100 potatoes. Next year, $110 buys you the same 100 potatoes. That's 10% inflation. Even if it doesn't seem like much, it adds up.

Inflation is natural but hasn't been this high in 40 years. Unfortunately, it also shows no signs of slowing down. The issue is that salaries don't go up as fast as inflation is right now. People are getting priced out of their own life.

When you hear 8% inflation, that's a big deal. Imagine living paycheque to paycheque, and then you're suddenly 8% short on your rent (and your life). The average salary increase is 2% per year.

But - has anyone ever told you how it actually gets measured? Or why it's controversial?

Let's get into it.

Measuring inflation (a little crazy)

The government has a job for this - a "recorder." They collect data on prices each month. The way it's done blew my mind.

They literally walk into stores across the country (LA, Chicago, New York, etc) and write down the prices. They sometimes call and ask people how much they're paying for things.

These recorders work for the United States "Bureau of Economic Analysis" and publish monthly reports. We're talking specifically about the report on "Personal Consumption Expenditures Price Index." Feel free to read through it for yourself.

There are over 90,000 products tracked across different categories.

1. Food & Beverage

2. Housing

3. Clothes

4. Transportation

5. Education

6. Recreation

7. Medical Care

8. Services (eg. oil changes)

Everything from rent to haircuts and more.

When you hear that inflation is 8% this month, it means the blended average across these products and categories is 8% more in July of 2022 vs July 2021.

Some things have more "weight" when calculating this average. For example, 8% on rent is a much bigger deal than 8% on your haircut. Food is another big deal. You get the idea.

That's how inflation is measured, so why is it a big deal?

This approach has some problems.

1. It Doesn’t Catch "Shrinkflation" - companies start giving you less.

   1. Ex. A 400g bag of chips was $4. Now, a 300g bag is $5. Recorders catch the $1 increase, but not how there are fewer chips in the bag. FYI this happens a lot.

2. It Doesn’t Factor In Different Purchases In The Same Category - people downgrade when prices go up.

   1. A piece of double organic fish may cost much more than it used to. So, people switch to canned tuna. They're not recorded paying more for fish because they're buying cheaper fish. Gets missed.

3. Different Lifestyles Have Different Inflation - If your lifestyle is to eat steaks, travel often, and buy nice cars - you may have a different inflation % than someone who lives a different lifestyle.

   1. Inflation effects people who make less money much more so than rich people. The recorders don't catch this.

The biggest criticism: if a government can cause inflation, it may have a good reason to "miss" some numbers here and there as they track and report everything.

This is why when you hear 8% inflation, some critics might suggest it might really be 9.5% or more.

Are you at risk? Here's what you should watch out for (bonus)

Remember what we mentioned earlier? Salaries don't go up nearly as fast as inflation. As the pressure increases with prices, companies are often faced with tough choices.

Raise prices or cut expenses (or both)? The most effective expense to cut is typically salaries. That's why this might impact you.

Here's what to watch for:

• Is your company raising prices? They should be. Red flag if not.

  • Exception: your company is already the most expensive option. That's (usually) fine.

• Has your company announced any kind of "hiring freeze" publicly or low-key?

  • Most companies stop hiring too late. Cuts usually follow. Prepare yourself just in case.

• Is the product/service not as good as it used to be?

  • Remember the bag of chips? People may not notice at first, but they will eventually. This is how big companies go bankrupt - cutting corners.

All of this adds up to one thing: take care of yourself first. Don't be afraid to consider different work opportunities.

It's not 100% doom and gloom, and it's always possible to upgrade to a better job. We're big believers in starting a side-hustle just in case. Reply to this email if you have any questions. We have some resources that might help. Feel free to ask anytime.

Thanks for reading!

All the best,