Let’s Put Indexing on the Index

Originally published April 5, 1982

THE REAGAN Administration is finally taking a sensible and practical (though partial) step toward solving the inflation-and maybe even the stagflation-problem. Work is under way on revision of the Consumer Price Index. It would be better to abolish the CPI altogether, and the Wholesale Price Index and the GNP Deflator along with it; but I’m pleased as Punch to be able to say that at least one step of Reaganomics is pointed in the right direction.

Democrats, of course, will regard the maneuver bitterly, for it is another example of Republicans changing the rules of the game, and getting away with it. Nixon was a master of the trick. He built his political career around claiming the Democrats had lost China, and then triumphantly discovered that Mao and Brezhnev weren’t the same fellow after all. And in the field of economics he trumpeted the old-time laissez-faire line until August 15, 1971, when he bowed to the public opinion polls and suddenly imposed wage and price controls. (Characteristically, he muddied discussion from that day to this by proclaiming, “We are all Keynesians,” though you will search The General Theory in vain for recommendations for wage and price controls.)

Jimmy Carter has reason to be especially bitter. For it was the CPI-and what he did about it-that did him in (if it hadn’t been for Iran, he wouldn’t even have been renominated). Possessing a touching engineer’s faith in statistics and an upwardly mobile boy’s awe of the wisdom of rich men, Carter thought the CPI was real, and that “business confidence” (actually bankers’  and brokers’ greed-induced blindness) required the appointment of a hard-core monetarist as Federal Reserve Board chairman.

To “control” inflation, the Fed promptly sent the interest rate through the roof. But the interest rate is a large factor in the CPI; consequently that, too, went through the roof, dragging all indexed wage scales and transfer payments along with it in a self-sustaining escalation. That wasn’t all, but it was enough to send Carter back to Plains, where, if he is given to second thoughts as well as second birth, he must marvel at the Reagan magic of controlling the rate of inflation by changing the way the rate is calculated.

As I say, however, revising the CPI isn’t quite enough to satisfy me. I want to abolish it, because the whole business of indexing rests on confusion as to what measuring-any measuring-is.

Measuring is a comparing of something with some standard. For example, by laying a metric ruler across this magazine you determine that the page is about 21.6 cm. wide. But how long is a centimeter? Well, a centimeter is 1/100 of a meter, which is 1/1000 of a kilometer, which is 1/10000 of the surface distance from either pole to the Equator or one-quarter of the vertical circumference of the earth. What is the circumference of the earth? This distance is calculated from various observations, which themselves depend on measuring, not only of angles but of distances, so that the meaning of a centimeter is ultimately a function of whatever units of measurement are used as the basis of the calculation. When the calculation was first made with reasonable accuracy, by Eratosthenes in the third century B.C., the basic unit was the stadium, which may or may not have been equal to 600 of somebody’s feet. More recently, before the introduction of the metric system, the unit was the yard, or the length of some king’s stride.

In short, the precision of the length of a centimeter depends on a foot or a yard, or cubit or rod or league or something, and that something has to be absolute. The relation between measuring stick and thing measured is not reciprocal. You can’t use the metric system to calculate the circumference of the earth, for your argument would be truly circular. You might just as well start right out and say-as we actually do say that the distance between two scratches on a certain platinum bar in the Bureau of Standards is a yard, and no fooling.

Although the measuring unit is absolute, it is not a convention. The scoring systems of sports are conventions. Davis Cup tennis doesn’t use the tiebreaker; my friends and I play the nine point sudden-death tie-breaker; most tournaments use-lingering death. These are all conventions. There is nothing necessary about them, because (painful as it is for me to admit it) there is nothing necessary about tennis. Spatial measuring, however, is necessary. Spatial units define space; without them the physical world is formless, and everything we make is impossible. It does not matter whether we measure in yards or meters or cubits; we must measure, or rely on the measuring of others, if we are to have a physical world.

It is the same with money; without it we have no economical world. It is common to talk as though we had a  functioning economic system-complete with land, labor, capital, trade, commercial law, liquidity preferences, and the rest of civilization-and then, just to make this system work a bit more smoothly, we added money to it as a sort of lubricant. Yet this is not the case at all. Our civilization cannot exist without money. It did not merely happen to come into existence with money. It does not exist without money, because it depends upon measuring, and economic measuring is done with money.

Nevertheless, people speak of the purchasing power of money and call attention to the declining value of the dollar. These ways of speaking seem to assume that money has value, like any good or service, and that this value can be measured.

Measuring the value of the dollar means comparing it with the “market basket” of the Consumer Price Index or something similar. Despite the fact that the contents of the market basket can be changed by executive or legislative or merely professional fiat, the basket seems real, while money seems only nominal, or, as Marx called it, “a purely ideal or mental” form of value. But if the value of money is in terms of a market basket, the basket becomes the standard of measurement, and money becomes a commodity [Editor’s italics].

Now, there is no objection in principle to making the market basket, or any part of it, our unit of account. As everyone who has had a little Latin or Anglo-Saxon knows, many ancient peoples counted wealth in terms of cattle, as the Masai still do. This may be clumsy and imprecise, it is not impossible. But if we take that approach, we should not kid ourselves-as I fear our econometricians do-into thinking we have established a “constant dollar.” No market basket is the same to different individuals at any given time (my wife and I set up housekeeping a number of years ago; so we are now relatively unconcerned with the price of furniture). Nor is the basket the same in different historical situations.

Of all the things in the basket, the price of bread is sometimes urged as basic, and it was indeed central in the French Revolution. But today food is so much smaller a part of the family budget, and bread so indifferent a part of the diet, that all the bakeries in the land could shut down tomorrow without causing much more inconvenience than the air controllers’ strike. The same holds true for the GNP Deflator: The price of steel is far less important to me, a book publisher, than it is to a builder of office buildings; and it is more important to a builder at present than it was before the elevator and the electric light made skyscrapers possible.

SUCH DIFFERENCES and changes are occurring all the time. Money measures them. Money is not and cannot be “constant,” because the economic world is not and cannot be constant. The natural world is and must be constant; the normal temperature of the human body is 98.6°F. today and will be the same next year or next century. The world of economics is not natural; it is historical. It is not physical; it is ethical. In it things are done; they don’t simply happen.

Indexing-like so many other things economists have done from Adam Smith onward-is an attempt to reduce economics to an automatic happening. It is also in direct conflict with the system it pretends to serve.

Most economists say that the subject matter of economics is the allocation of scarce resources. (Please note that I don’t say that.) And most go on to say that a market economy, through constant shifts in the relative prices of goods and services, is the most efficient way of accomplishing the allocation. (I’ll assent to that). But the sole purpose of the CPI-and of all the other attempts to measure with “constant” – is to nullify market price shifts. If all prices went up (or down) in precise lockstep, there would be no point to trying to freeze them with an index. Inflation is not every price going up simultaneously; it is some going up much faster than others, with the result that last year’s values are not this year’s, to the delight of some people and some countries, and to the dismay, or even the distress, of others.

Am I saying that inflation is not really a problem that we wouldn’t even be aware of it if we didn’t have indices, and that it would go away if we abolished indices? Well, I am saying something pretty close to that. I’m far from saying that there are no distortions in the economy or that we can do nothing about them; but I am saying that these distortions don’t just happen, and that indexing only makes them worse. And I do make the empirical observation that the three modern economies with the worst inflation experience-Weimar Germany, Brazil and Israel-have all been comprehensively indexed.

Attend with humility to the 1923 lament of Hans von Raumer, Minister of Economics in the second Reich: “The root of the evil is the depreciation adjustment [that is, the index]. Inflation goes on unchecked because one must add enormous increments for depreciation onto wages and prices alike, and these in their turn work in such a manner that the depreciation provided for actually occurs through the inflation thus caused.”

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