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Montana Viewpoint
PAYING MORE FOR LESS<
Will inflation make our lives more interesting?

August 7, 2006

Well, I sat down to write an article on how government-reported inflation measures seem way off from my personal observations as a consumer, what with fuel at three bucks and rising. But as I was researching the issue I got an unintended education and a rude reminder of past history.

I think when most people, or at least this person, think of inflation, they think of how much more money they have to pay for life’s necessities. When economists measure inflation, they are more interested in how much the buying power—or value—of the dollar is falling. You may have noticed that pennies are becoming of insignificant value to Americans, with “penny jars” as prevalent on check out counters as a bowl of M&Ms at a party.

Inflation is measured in many ways, but the best known measure is the Consumer Price Index (CPI) which keeps track of the cost of a “market basket” of products bought by typical consumers. The contents of the market basket are revised every ten years.

One reason to measure the cost of living is so the Federal Reserve Bank can figure out how to keep the economy in that delicate balance where growth doesn’t create inflation. Which leads to the rude reminder: the economic situation today is eerily reminiscent of the late 1970s when inflation soared and the economy tanked. Why? Oil prices, of which more later.

A year ago I attended a presentation on the state of the American economy by a fellow from the San Francisco Branch of the Federal Reserve Bank. It was notable, because in the course of the presentation he said that inflation was well under control. At that time gas had hit the two buck level and groceries seemed more expensive than ever. Was it just me that was confused?

That’s when I was re-educated about “core inflation” which is measured using a formula called the Core Consumer Price Index [Core CPI] Core CPI excludes fuel and groceries. Well, no wonder I was wrong. Here I thought that I was shelling out a lot more money, only to find out that my two major expenses didn’t figure in government inflation measures.

The stated reason for leaving energy and food out is that because their prices are volatile—rising and falling all the time—including them in the CPI gives an inexact picture of what is really happening with inflation. The Core CPI gives a more accurate picture, and also rises a lot slower than the inflation rate as measured by the CPI.

Now for the rude reminder, courtesy of the Cleveland Branch of the Federal Reserve Bank: “Increases in oil prices and the funds rate [interest rate] have preceded every recession since the early 1970s.” 

O joy! But wait! There’s more! Because higher oil prices dampen economic activity the tendency of the Federal Reserve is to lower interest rates. This is intended to spur economic activity by making capital more available to businesses.

But oil price increases also lead to higher inflation [go figure why they leave it out of the core CPI]  and the way to control inflation is to raise the interest rates to make money less available. The conundrum is, do you lower the rate to spur the economy, or increase it to hold inflation at bay.

What do you want, recession or inflation? Well hey, you can have both, because that is exactly what happened in the 1970s and early 1980s; inflation sky-rocketed and the economy tanked, leaving newly unemployed people with less money to buy higher priced goods.

It was called “stagflation” and it was not a happy time for America. If we really want to look at the dark side of things, the enormous federal deficit that is being racked up by costs for the war in Iraq and the cost of tax cuts for the wealthy is no small potatoes issue in our economic future either.

I hope I am wrong. I’ve always tended to dwell on the negative aspect events, but there is an upside to being pessimistic; I’m most often right, but sometimes pleasantly surprised.

 

Jim Elliott
Phone: 406-444-1556
Mail: State Senate Helena, MT 59620

jim@jimelliott.org