Why inflation data will be even less representative of your cost of living this year

Forgive me for writing about some really arcane area of macroeconomic statistics, but the pandemic is creating all kinds of weird effects in the macro world. For one, because of the massive disturbance from the pandemic to the global economy, macro forecasts are currently even less reliable than they normally are (which is saying a lot). But because of the way some macroeconomic aggregates are calculated, they are currently becoming less representative of what is really happening in the economy than before.

Earlier this year, the Office for National Statistics in the UK and the statistical offices across the EU published the new weights with which products and services are entering the basket to calculate consumer price inflation. Unlike in the United States, where weights of products and services are adjusted a little bit each month, in Europe and the UK, the weights are adjusted once a year based on the consumption patterns of households in the previous year or so and then left unchanged for 12 months.

But thanks to the pandemic, our consumption patterns have changed significantly over the last two years. Relative to other items, we spent less on transport (both for commuting and for pleasure). Less on restaurants and less on recreation and entertainment because – well – we couldn’t go out most of the time. And as we spent less on these items, the relative weight of other sectors like housing, food and clothing increased. The chart below shows the shift in weights in some of the sectors impacted by Covid in the UK that are put in place at the start of 2022.

Change in sector weights of different goods and services in the UK 2021 vs. 2022

Source: Office for National Statistics

If I add up the weights of sectors that have been adversely affected by Covid and the weights of sectors  that have not been affected you end up with a pretty dramatic shift Away from Covid sensitive goods and services.

Change in sector weights of UK goods and services affected by Covid and those that weren’t

Source: Office for National Statistics

But that is a problem in 2022 since it becomes increasingly clear  that we are going to leave Covid restrictions behind and are returning to a more normal lifestyle that involves international travel and going out again. So right at the time when we are likely to start spending more on these goods and services again, the weights are reduced, thus creating a somewhat distorted picture of inflation going forward and – I guess – a somewhat lower headline inflation than we really experience.

Because of the different methodology in the United States that is not a problem there, and normally, the changes in weights are so small that they are not noticeable. But in many countries around the world the pandemic will lead to significant shifts in inflation baskets and make inflation number less representative and less comparable to the US numbers.