Tuesday, May 10, 2005


No, not ebonics, that right-wing scare word of the Political Correctness crusades of the 1990s. We're talking hedonics, a controversial method of attaching a value to the increase in pleasure new goods are supposed to provide, which in turn can be weighed against periodic price increases to keep the rate of inflation down. I never heard of hedonics until the Wall Street Journal mentioned it yesterday in an front-page article about hidden inflation and its eventual effect on bond investors. (Bonds need to beat the rate of inflation to make sense as an investment, but if hedonic adjustments mask as much as 3 percent of inflation, then bond owners may actually be losing money in the long term without realizing it, finding themselves suddenly unable to get the anticipated value of their money in goods when the bonds come to term.)

I've spent this afternoon trying to figure out the rationale for hedonics, and just how it is one can measure the marginal pleasure afforded by innovation in the commodities on the market. Apparently, the gist is that there is a straight conversion possible that translates quality improvements into price reductions. A typical example cited by the irate investment bankers who tend to write/blog about this topic is a computer: If it's twice as fast and you pay the same price, hedonics concludes that you're getting twice as much for your money, and that the price of computers have been cut in half -- even if what you are using the computer for hasn't changed a whit. (My computers get faster but I keep "processing words" at the same stubbornly slow rate.)

Economists may have a sophisticated mathematical defense for hedonics as a regression analysis of some kind, but it seems like the adjustments ultimately boil down to introducing the deeply flawed psychology of utility theory into the calculations of the CPI, which ultimately affects how much grandma gets in her Social Security check, and how much your inflation-protected securities are really going to be worth. It may be that the value of money is always contigent upon one's willingness to adopt that vulgar utilitarian mindset as a personal ethos. Money is only worth the joy you get in spending it, thus protecting its value is mainly a matter of protecting those pleasures that derive from it -- which usually consist of trying to make more of it, faster. Thus back to the utilitarian bias again -- more is always better, and too much is never enough.

1 comment:

  1. Suggested (moderately technical) reading on the rationale for hedonics: Ariel Pakes, "A Reconsideration of Hedonic Price Indexes with an Application to PC's" (American Economic Review Vol. 93 No. 5: 1578-1596).

    Regarding your computer example, it may be worth noting that hedonic adjustment doesn't imply that a computer that's twice as good but the same nominal price as a predecessor has a hedonic price half that of the earlier model. The factor of proportionality in the hedonic analysis depends on the derived demands for the qualities of the goods in question.

    It's possible to make a case that the hedonically-adjusted CPI actually understates computer deflation, which I sketched here.