Nathan Rothschild was the richest man in the world when he died in 1836.  A list compiled by Forbes magazine, ranks him as the second richest man who ever lived – ahead of John D. Rockefeller, and way ahead of Carlos Slim and Bill Gates.  (The richest was a Roman general who was the power behind Julius Caesar’s throne). The figures used by Forbes are, of course, adjusted for inflation

But what does ‘adjusted for inflation’ mean?  Rothschild died of septicaemia following an abscess, and in spite of the best medical attention available in Europe at the time.  Nathan Rothschild  had never been in a car, a train, or a plane, visited the Taj Mahal, heard recorded music, seen a film, made a telephone call or used electric light.  Nor (despite the legends) could he have heard about the outcome of the Battle of Waterloo until many hours after it had been resolved.  And he was dead at the age of 58 from an illness that could today be cured by an antibiotic costing a few cents. 

      Was Nathan Rothschild really the second richest man in history?   Was he, in fact, richer than me?  True, he could hire a posse of postillions and eat off gold plate, but I would happily trade them for still being alive, and I suspect that Nathan would have felt the same.

The question is prompted by a considerably more mundane event. Inflation in the eurozone has fallen to 0.3%, arousing concerns that there might actually be deflation in the months ahead – that Eurostat will soon declare that prices in Europe are lower than a year earlier.

       That worry is premised on the existence of a qualitative difference between inflation – prices rising, even if slowly – and deflation – prices falling, however swiftly. On an assumption that deflation is undesirable and the goal should be gently rising prices.  And on the belief that we would be able to tell which state we were in.

Contemplation of the antibiotics not available to Nathan Rothschild casts doubt on all of these premises. It is generally accepted that medical costs increase faster than general inflation – and in the United States, where they represent over 20% of consumer expenditure, they have been a significant contributor to that general inflation.  But medicine has got better – quite a lot better, even if too late for Nathan Rothschild.

Price indices are compiled by measuring the changes in the cost of buying a fixed bundle of goods chosen to represent the consumption of an average household.  But what the average household buys changes with the arrival of new goods, changes in relative prices, and variations – good and bad – in quality.  Antibiotics replace leeches, postillions become more expensive, computers become more powerful, and the service from a call centre gets worse. That is how  modern economies evolve and grow.

But price indices find all these changes hard to cope with.  The bundle of goods Nathan Rothschild bought in his day might now  be prohibitively expensive even for Nathan Rothschild – the postillions, the gold plate, the mansions – and certainly very different from the bundle of goods Bill Gates would want to buy.  And the difference in consumption patterns of an  average household is more dramatic still.

There are techniques for measuring and incorporating quality improvements, which are used for many consumer goods, but for medicine which is measured in basically expenditures rather than prices. And a mechanism of chain linking attempts to sidestep the impossible task of comparing consumption in 1836 with that of 2014. Overall, there are probably more upward than downward biases in the way inflation is calculated. But to claim that we know that prices have risen by 0.3% in the last year implies a degree of precision in our estimates to which we cannot realistically aspire.