Should we worry about rising inflation? September’s Consumer Price Index showed an increase of 1.22 percent in just one month. The Producer Price index came in even higher at 1.9 percent. Whether this merits great concern depends on how you define “inflation.” It also depends on whether Milton Friedman was right in his assertion that “inflation is always and everywhere a monetary phenomenon.”
There is no official definition of inflation, but most economists take it to mean “an increase in the general price level.” All prices don’t have to increase to have inflation. Moreover, prices of a few items can spike without true inflation. Exactly what constitutes an increase in the “general price level” is ambiguous.
That ambiguity is the problem in the September numbers. Converted to annual rates, consumer and producer prices rose 15.7 percent and 25 percent respectively. That is raging inflation by U.S. standards.
But if you strip out energy costs, consumer prices increased at an annual rate of just 1.8 percent. In August and September, nonenergy producer prices rose at the same annual rate. Except for energy, this nears the Holy Grail of “price stability” sought by economists.
A sharp increase in oil and gas products is not necessarily inflation, particularly when a discrete event like Hurricane Katrina has disrupted supplies. The inflation dragon is not breathing fire at the drawbridge.
But complacency is dangerous. Even if one month’s energy prices do not inflation make, households and businesses that pay more for fuels have less to spend on other items. But households don’t like to cut consumption, and businesses want usual profit levels.
In this situation, workers naturally seek higher pay, and businesses want to raise prices. If they succeed, then increases in prices can become general. True inflation will rear its ugly head.
That can happen only when excess money sloshes around the economy. And that only happens when the Fed increases the money supply too fast.
History has proven Friedman’s famous dictum correct. Myriad circumstances can boost prices of specific goods or services. But increases in general price levels occur only when central banks like the Fed fail in their responsibilities.
The upshot is that September’s price index numbers are a good-news, bad-news story. The good news is, there is no outbreak of inflation at the consumer level. The bad news is that inflationary pressures are building. Inflation will rise if monetary policy is too loose.
The catch is that while nonenergy consumer and producer prices remain mostly stable, broader measures of inflation show many signs of inflation. Prices of housing, corporate stocks, nonagricultural commodities and gold all warn that money has grown too fast, and for too long. Cheap consumer goods and loans to the U.S. Treasury from China have masked the problem. Prolonged high energy costs will exacerbate the situation.
We are not out of the woods yet.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.