FreedomWorks Foundation Content

The World Has Not Solved The Problem of Inflation

Throughout the various rounds of quantitative easing enacted by the Federal Reserve in response to a persistently sluggish economy, advocates of loose monetary policy have kept a gleeful eye on the Consumer Price Index, pointing to the lack of measured inflation as evidence for the soundness of their ideas and the groundless paranoia of their detractors. Now, commentators with a Keynesian bent are claiming that through the miracle of economic engineering, inflation no longer poses a global threat the way it once did. The problem has been “solved” and we can all stop worrying about it forever.

It is true that the CPI has shown remarkably little movement of late, despite unprecedented levels of government stimulus and vast increases in the money supply. The Bureau of Labor Statistics reports a twelve month inflation rate of a mere 1.7 percent. The Bureau of Economic Analysis, using the GDP Deflator instead of the CPI, reports a higher, but by no means worrisome inflation rate of 2.7% for the third quarter of 2012. In light of these figures, it is not hard to understand why so many now scoff at the threat of inflation, but there is some reason to believe that these numbers are not telling us the whole story.

To begin with, it should be pointed out that both of the aforementioned agencies responsible for calculating inflation are run by the federal government, and are therefore potentially subject to political pressures. It is always in the current administration’s best interest to represent the lowest level of inflation that can be credibly reported, and so it is possible that conscious or unconscious biases could influence the methodologies of these calculations.

For example, the CPI is calculated by measuring the change in prices of a predefined “basket” of consumer goods over time. For security reasons, it is not possible for the BLS to publish the specific contents of this basket, and so we have no way of knowing how representative it may be. Most of us have probably experienced noticeable increases in the price of groceries in the last year, and the fact that BLS’s food index has only risen by 1.8% appears at odds with reality when we consider that the price of apples rose 12% in 2012, oranges rose 11%, ground beef rose 5%, and chicken rose 11%. One has to wonder what types of food they think we have been buying.

But even if we assume the purest motives and most dispassionate self-examination by BLS analysts, there are other problems inherent to the CPI that render it a questionable measure of the true inflation rate. Inflation is fundamentally a measure of changes in the value of the dollar, consumer prices can change for all sorts of reasons unrelated to this. An early freeze could cause a spike in produce prices while a technological breakthrough could cause electronics prices to fall, all of which would be unrelated to the value of money. It is impossible to know how much of the CPI’s change (or lack of change) is due to external factors and not to inflation at all. While the basket of goods is meant to remain fixed, what happens when the original good no longer available, at least not in the same size and quality as before? How do you compare the price of a home computer in 1990 to the price of one now, when the technology has advanced so far that it can hardly be considered the same product?

Before the U.S. abandoned the idea of backing its currency with commodities, the value of the dollar would have been measured in gold, the price of which has risen nearly 8.5% since the start of 2012. I am not suggesting that the price of gold is an accurate measure of inflation, but merely pointing out that the question is not so simple as some would have us believe.

Even if the official numbers are correct, it does not follow that inflation is no longer something to be feared. Some analysts theorize that the reason increases in the money supply have not been met with more inflation is that people are still reluctant to spend. If this is true, we could be facing a wave of built up inflationary pressure that will break once consumer confidence returns to the economy.

We would be wise not to become too sanguine regarding the problem of inflation, which has wrecked more than one economy in the past. An increase in availability is always accompanied by a decrease in value, and this is as true for dollars as for any other good. One way or another, increases in the money supply will always be reflected in the price level.