Inflation is an increase in the supply of money. So when the government prints more money, or creates more through bookkeeping transactions at the Federal Reserve, that is inflation. The result of inflation? Higher prices.
But, of course, the government and those who favor big government don’t want you to know that they are the cause of higher prices. So over the last 30 years or so, they have developed a new definition of inflation: Inflation is a rise in the general level of prices. So now, instead of inflation being the cause of higher prices, higher prices are what cause inflation. Or at least higher prices and inflation are one in the same.
This is very convenient for government because with this definition it is difficult to blame rising prices on the government. Instead, we can blame rising prices on wars in the Middle East, bad weather in the Midwest, and wage increases due to an overcharged economy that needs slowing down.
Still, people don’t like rising prices. And should prices rise too fast for too long, people will eventually get upset. But never fear, it looks like Paul Krugman has figured out a way to solve this inconvenient problem as well:
US core inflation has ticked up slightly recently. What’s that about?
I’ve suspected that what we’re really seeing is the inadequacy of even core inflation as a way to purge transitory effects of volatile prices: the measure takes out purchases of food and energy, but it doesn’t take out indirect effects of raw material prices on costs. New research from Goldman Sachs (no link) seems to support that view: it finds that core inflation is getting a temporary bump from the prices of imported raw materials, and will probably subside if the commodity surge is in fact over.
This in turn suggests that policy should really be based on some kind of “supercore” inflation. Should this simply be wage growth? Adam Posen at the Bank of England has certainly gone well down this route, arguing that the relatively high rate of even core inflation in the UK reflects one-off factors and that stagnant wages show that there are few risks. And I totally agree with Posen about the UK policy issues.
Yet there are problems with a wage target – mainly, you don’t want to base policy on the notion that wage gains are always a bad thing. Maybe adding a trend productivity adjustment would do the trick. More systematic thoughts when I have time.
Anyway, the bottom line for now is that neither the Fed nor the ECB should be at all concerned about inflation.
In other words, when measuring inflation, we shouldn’t worry about how much food and energy cost. Neither should we worry about the cost of raw materials.
I suspect what Krugman really wants to do, as he alludes to in the last sentence, is ignore inflation all together. If he could get everyone else to join him, that would make it really easy for people in the government to print more money and thus avoid having to raise taxes to support their spending habits.
-Bill Peacock