‘The UK suffered the highest rate of inflation in two-and-a-half years in April’ Financial Times, May 18
“Dad?”
“Yes, my love?”
“What’s ‘inflation’?”
“An excellent question. You will no doubt remember that when the tooth fairy came for your first tooth, she left you 50 pence. But, more recently, the going rate has been a pound. That’s inflation.”
“So, inflation is when my income goes up?”
“No, that is not the point at all. You must see it from the perspective of the tooth fairy. Inflation is when the price of goods and services rises. Your teeth are in no way increasing in value and yet their price has risen. That is inflation and it’s easy to see why so many people get jolly worried about it.”
“Well, I can see how the tooth fairy might be upset about it but if I’m selling a valuable tooth for twice the price, I’ve come out ahead. There are winners and losers. Why would society as a whole be worried about inflation?”
“You are a perceptive child. True, the doubling in price of your tooth alone cannot be regarded as inflation because, as you imply, it’s a doubling in the value of teeth relative, say, to chocolate brownies. If you are selling teeth and buying chocolate brownies – as in your case – then it is no bad thing.
“I should have said that inflation is a generalised rise in the price level, when the price of everything is rising. People may have more pounds and pennies in their bank accounts because they are being paid more for their skills but their ability to actually purchase goods and services has not increased.”
“So, when all goods and services simultaneously increase in price by the same amount over the same time period, that’s inflation?”
“Exactly so.”
“Does that ever happen?”
“No, not really. Actually what is happening is that the prices of some goods are going up, others are flat and some are falling. So the rate of inflation is the average of what is happening to all those goods.”
“That’s very interesting, Dad. Thank you.”
_______________
“Dad? I’ve been thinking. Mum buys groceries from Ocado and fancy computers with apples on them. You buy funny-looking beers from Belgium and sometimes you buy chocolates for Mum and eat them when she’s not looking. And the tooth fairy buys teeth. Don’t we all have a different rate of inflation?”
“Not according to the government. The Office for National Statistics calculates various measures of inflation and they are used to make adjustments. For instance, RPI, the retail price index, is often a bit higher than CPI, the consumer price index. But you are probably right. There are certain newspapers that enjoy finding a group of people who probably have a higher inflation rate than the nation as a whole. But what is to be done about that? I can hardly expect the Office for National Statistics to calculate my own personal inflation rate, based on what I decide to buy.”
_______________
“Dad, I’ve been thinking. You say that your personal inflation rate depends on what you decide to buy. But what does what you decide to buy depend on?”
“As an economist, my darling, I obviously pay close attention to price changes.”
“But if what you decide to buy depends on the way prices change and calculating your personal inflation rate depends on what you decide to buy, I’m confused. Aren’t we going round in circles?”
[Father rummages in fridge for expensive Belgian beer]
“You have a point, dear. If these beers get any more expensive I shall switch to Australian lager. I will have experienced inflation but precisely because of that inflation, the expensive product will no longer be something I purchase.”
“Doesn’t that make it hard to calculate inflation?”
“My dear, it makes it impossible. We can only ever have an approximation to anyone’s true inflation rate – if the concept itself makes any sense – so we have to make do with that.”
“Dad, I’m worried. Will the tooth fairy stop buying teeth if they get too expensive?”
“No, my love. The tooth fairy can create money by magic.”
“Didn’t you tell me once that only Mervyn King could do that?”
“I forgot that I said that. Yes, I overlooked the tooth fairy. But Mervyn King and the tooth fairy – they’re the only ones.”
Also published at ft.com.