Fed paper presents new way to measure consumer welfare

Consumer welfare was higher in 1955 than 2019, finds a researcher at the Federal Reserve Bank of New York. 

Danial Lashkari argues that traditional measures of wellbeing and welfare do not account for the differences in consumer preference observed across income levels. Lashkari’s paper measures wellbeing using income and household-level inflation data. 

He ties household consumption to the basket of goods and services associated with each household’s income. “Households choose different baskets of goods and services that systematically depend, among other things, on their income,” he says. 

Consumers with different incomes purchase different goods, and the pricing behaviour of different goods varies. Prices rise more slowly for luxuries, so high-income households experience less relative inflation, the author points out. 

“When income is growing, consumers are actually better off than that suggested by all available measures of real consumption,” says Lashkari. “The conventional measures of inflation and real consumption miss this mechanism altogether.”

Traditional measures, he says, assume that consumption preferences don’t change as incomes shrink or grow. But he argues that recent research into the inequality inherent in inflation provides a reason to disagree with that assumption.  

Lashkari built a dataset from 1955 to 2019 that linked household income percentile to price changes and expenditure. 

“This new linked dataset allows us to provide evidence on the inequality in inflation over a long time horizon, thus extending prior estimates that have focused on shorter time series,” he says. “We find that inflation inequality is a long-run phenomenon.”

Since 1955, prices have increased by a factor of 10 for households in the bottom income groups, but by eight for those at the top. 

“The gap in inflation experienced by different income percentiles is sizeable when compared to the overall size of inflation over the period,” says Lashkari. 

Households have a higher preference for luxuries in 2019 than 1955, he finds. And necessities were cheaper relative to luxuries in 1955 as well. 

“These empirical patterns imply that consumer welfare was higher sixty-five years ago when accounting for the dependence of preferences on income,” he says.

Traditional measures of real consumption show 2.07% growth annually, says the author. His method estimates the real figure is 1.89% annually. Using his method, “we find that the annual growth rate from 1955 to 2019 is lowered by 18 basis points,” he says.