What makes the Underlying Inflation Gauge (UIG) unique is its power to distinguish between changes in the cost of living and changes in the rate of inflation. Did you think those were the same thing? Think again, and read on.
What’s the difference?
The concept of the cost-of-living stems from the first of those role of money as a medium of exchange. When we say the cost of living increases, we mean that it gets harder to maintain a given standard of living on a given income. Either we have to be satisfied with fewer goods or services, or save less, or work harder. In the language of economics, a change in the cost of living is a real phenomenon.
Inflation, in concept, is best understood a change in the value of our unit of account, the dollar. When there is inflation, the value of the unit is smaller each day than it was the day before, for all transactions.
Imagine that you woke up one morning to find that someone had chopped an inch off all our rulers, so that today’s foot was now only as long as yesterday’s eleven inches. You might go from being six feet tall to six-foot-six, but it wouldn’t be any easier for you to reach the top shelf in the kitchen without a footstool. Similarly, if inflation raises both your income and the prices of everything you buy by the same percentage, the value of a dollar as an economic ruler shrinks, but it is neither harder nor easier to maintain the same real standard of living. In that sense, inflation does not measure anything real. It is a purely nominal phenomenon.