There Is Shadow Inflation Taking Place All Around Us

Inflation has surged in 2021, with various official measurements of consumer prices rising faster than they have in years. But in a crucial respect, the data may be understating things.

Many types of businesses facing supply disruptions and labor shortages have dealt with those problems not by raising prices (or not by only raising prices), but by taking steps that could give their customers a lesser experience.

A hotel room might cost the same as a year ago — but no longer include daily cleaning services because of a shortage of housekeepers. Some restaurants are offering limited service, with waiters stretched thin. Would-be car buyers are being advised to be flexible on the color and even make and model, lest they face a long wait to get their new wheels.

Customer sentiment on restaurant cleanliness fell 4.2 percent this year, according to Black Box Intelligence, which tracks online reviews of 60,000 restaurants. Complaints have been frequent about the cleanliness of tables, floors and bathrooms. Satisfaction with customer service was also down, especially regarding beverages, with guests complaining more about receiving the wrong order or no drink at all.

People trying to buy appliances and other retail goods are waiting longer. According to J.D. Power, even at the highest-rated retailers, only 57 percent of customers were able to get customer service within five minutes this year, down from 68 percent in 2018.

Government statistics agencies try to take changes in product quality into account when calculating inflation. But that process, known as hedonic adjustment, most commonly applies to physical objects. It is relatively straightforward to estimate the value of, say, the quality of stitching on a shirt or the value of a backup camera on a new car. There is a whole world of inflation alarmists who argue that this process leads to the understating of true inflation.

But quality changes involving customer service can be ambiguous and hard to measure. The Bureau of Labor Statistics, which generates the Consumer Price Index, does not incorporate quality adjustment on 237 out of 273 components that go into the index, including the vast majority of services.

Alan Cole, a former staffer for Congress’s Joint Economic Committee who writes the newsletter Full Stack Economics, noticed these sorts of annoyances during a long drive through the Northeast this summer — fast food that took an awfully long time to come, poorly stocked condiment stations, soda machines that were out of stock. The dynamic became even more clear to him when he stayed in a hotel that had a large area designated for offering hot breakfast to guests — it was mostly empty, with a few sad mini-boxes of cereal.

For years, he had argued that official inflation measures actually overstated inflation, because there were many below-the-radar product improvements not captured by the data, like software that was becoming less buggy. Now, he concluded, the reverse seemed to be happening.

When there are shortages of labor or supplies, some businesses adjust mostly or entirely by raising their prices. Others find less obvious, less easily measurable ways to adapt. Consider, for example, rental cars versus hotels. Both were dealing with shortages. But they showed up in different ways.

“The car company just had to charge higher prices, while the hotel could take the hit through service quality instead,” Mr. Cole said in an email exchange. “We measure them in different ways. The car company’s problem gets measured as inflation, while the hotel’s problem is mostly relayed by anecdote.”

It is not unusual for businesses to deal with supply shortages through mechanisms other than price increases. Retailers don’t want to attract accusations of price gouging when goods are in short supply, especially in times of natural disaster. So they end up with empty shelves, a back-door form of rationing. In the 1970s, gasoline prices skyrocketed — but not enough to prevent long lines and rules around which cars could fill up on which days.

This particular economic crisis has had far-reaching consequences that have made economic data harder to interpret than usual. “Usually when there is a disaster, if you’re a macroeconomist it’s a blip on the radar screen,” said Carol Corrado, a distinguished principal research fellow at the Conference Board who has researched inflation measurements. “But we’re talking a different kettle of fish with the Covid shock, and the economic implications and costs have become much more challenging to measure than in the past.”

It would be difficult for government statistics agencies to try to measure these hidden costs and factor them into inflation measures, say people who study the data closely.

Customer service preferences — particularly how much good service is worth — varies highly among individuals and is hard to quantify. How much extra would you pay for a fast-food hamburger from a restaurant that cleans its restroom more frequently than the place across the street?

“What gets up to the level of a quality adjustment does become pretty subjective,” said Alan Detmeister, a senior economist at UBS who formerly tracked inflation data for the Federal Reserve. “If the Labor Department even decided they wanted to quality-adjust some of these things, they would have an extremely hard time doing it.”

In some cases, one person’s quality enhancement is another’s deterioration. Is online check-in at a hotel a desirable timesaving feature, or a loss of personal touch that has real value? Reasonable people can disagree.

Moreover, while there appears to be some shadow inflation in service industries, the reverse has arguably held true for many years.

Suppose you believe that restaurant food has become more varied and delicious over the last few decades, as chefs have become more skilled and creative. If so, maybe the 2.7 percent average annual inflation in full-service restaurant prices from 2000 to 2019 that the Bureau of Labor reported was too high.

It’s plausible to believe that’s true, and also that the 4.9 percent rise in those prices over the 12 months ended in August was too low if the effects of labor shortages had been fully accounted for.

This hints at why inflation bothers people so much — and why it’s a political minefield for the Biden administration. It’s not just the prices you see and the numbers that are fed into economic models, or the news headlines and central bank inflation targets.

It’s also that a given amount of spending buys experiences that are a little less satisfying, and that this adds up to an accumulation of frustrations that don’t necessarily show in the numbers.