of The Wall Street JournalReports about the decline in the rate of increase in the Consumer Price Index are confusing, as any economist who understands the difference between changes in relative prices and changes in the general price level (all prices combined) would think.Easing inflation increases chances of rate cut in September(Scheduled to be held on July 11, 2024)
Reading this story, a Martian who lands on Earth would realize that on this strange planet all prices are the product of inflation (or deflation), that there is no difference between inflation (or deflation) and changes in relative prices, and that an increase in the CPI teeth Inflation. To quote from the article above,
Rising home prices, which act as a proxy for rent prices and account for about a third of the Consumer Price Index (CPI), are keeping overall prices high.
If there is such a thing as “housing inflation,” a mystery remains: what happened to “product X inflation” in the other two-thirds of goods and services, say, bubble gum inflation? Did that also keep overall prices high? Or did the rest of the CPI exhibit “product deflation” (the opposite of the inflation seen during economic downturns)? Is the economy witnessing a constant battle between two evils: inflation of some prices and deflation of others? Or did some prices just rise and some fall? Relatively Whatever happens to inflation (or deflation), will they feed off each other? But then a contrarian economist would ask, as economists began to ask centuries ago, what could cause all prices to rise at the same time other than a change in relative prices? So what does it mean to talk about housing inflation or gasoline deflation?
A simple way to think about relative prices is this: Assume that only one price in the economy is fluctuating, and all other prices are constant (which of course means there is no inflation). A price that has fluctuated is fluctuating relative to all other prices (but in different ratios depending on the price). Mathematically, when one relative price changes, all other prices also change relative to it. Every price is a relative price compared to other prices. Relative prices are always changing, whether there is inflation, deflation, or neither. Clearly, we need to distinguish between these two phenomena: inflation or deflation on the one hand, and specific relative price changes on the other.
Ryan Vaughn’s latest book Price War (Cato Institute, 2024) The book contains many discussions of prices beyond this humble blogger’s chapter “Increasing Product Prices Do Not Cause Inflation.” Throughout the history of economic analysis, there is much theory and evidence supporting the hypothesis that inflation (a general increase in all prices, rather than a relative change in all prices) is due to an increase in the money supply beyond what economic agents require to transact. The prices of any goods or services observed and included in the CPI are made up of relative price changes. andWhen inflation (or deflation) occurs, the general level of prices changes. Reprinted below is a graph from one of Ryan’s articles in the book: The correlation between changes in the money supply and the estimated inflation rate supports the hypothesis that inflation is a monetary phenomenon.
Journalists and The Wall Street Journal He is not the only one who is wrong. Most journalists are just repeating the noise they hear, including many economists. Perhaps some economists are so keen to convey their knowledge in plain terms for journalists and commentators that the latter are led to think in plain economics. They seem to think that “inflation is the sum of all price increases” (and inflation, if it occurs, is only a part of price fluctuations). Other economists seem to happily forget about economic thinking once they graduate from grad school to become accountants working with large databases and advanced statistical software. Still other economists are primarily making political points, which generally boils down to saying that the government has things under control and is taking good care of “the people”.
In today’s economic newspeak, the language of relative prices seems to be disappearing, so that all we can think of is housing inflation, food inflation, and bubble gum inflation, all of which add up to (headline) inflation.
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Martians confused by Earth’s bubblegum expansion theory
