Friday, January 04, 2008

When is Inflation Considered Inflation?

So they always separate "core" versus "nominal" inflation. The reason they do this is that two items (energy and food) are very volatile and can easily over or understate the "true" rate of inflation.

Normally the Fed and other economy watchers are only concerned about the core rate as they should be. However, the past five years or so the price of energy and food has consistently been higher than the "core" rate of inflation. And while energy and food are volatile, being persistently higher than the "core" rate, to the extent of five years makes me wonder if it really matters if you separate it out from "core" inflation. People still have to pay for gas. People still have to pay for food. And the more it costs, the lower standards of living are.

In any case the chart below shows nominal versus core inflation. Bar the last quarter you'll see nominal inflation consistently exceeding core inflation.


Anonymous said...

People still have to pay for housing as well. If the Fed goes helicopter crazy and starts dumping money into the economy and it just happens to form a bubble in something that isn't part of the PCEPI, it creates the illusion that the Fed still has a whole lot of room to lower interest rates further because inflation looks a whole lot lower than it really is.

Personally, I think central banks tend to do a whole lot more harm than good. The benefits of making some prices more stable are outweighed by the distortion of relative prices due to the injection effects of the Fed increasing the money supply, and I think that centrally controlled interest rates are essentially no different from any other sort of price controls.

While I'm rambling, why the hell aren't we looking at M3 anymore? The cynical bastard in me (which accounts for roughly 75% of my personality) suspects that the Fed no longer tracks M3 because it would increase relatively more quickly than the other three measures of the money supply in the event that the Fed pumps out way too much liquidity.

Anonymous said...

About 3min in it talks about sub-prime in America. =)

Anonymous said...

Captain, I think the Fed doesn't take into account food or energy because they know that it is inflation that they cannot control with monetary supply. High inflation throughout the entire economy is a sign of too much money supply, whereas a few fast-rising product prices simply signify tight supply/high and growing demand.

David_Z said...

Why do most mainstream economists refer to "inflation" when they are really describing the effects of inflation?

Inflation is always a monetary phenomenon, no? So when prices rise in response to monetary policy, we can't call the rising prices "inflation," whether we preface it with "core" or "nominal," because it's simply not inflation, which is an increase in the money supply...

Anonymous said...

"High inflation throughout the entire economy is a sign of too much money supply, whereas a few fast-rising product prices simply signify tight supply/high and growing demand."

Or too much money supply that's going into a speculative bubble. Once you've got one of those rolling, new liquidity is likely to go straight into it. If it happens to be in something that the central bank doesn't measure as part of "inflation" they'll keep dumping money into it all day. Housing, for instance.

Even worse is when the things they do measure for inflation get cheaper at the same time due to increased output from places like China and India, prompting the Fed to further increase the money supply to keep those prices stable.