Unusual Worry: Is Inflation Too Low? Federal Reserve Worries Prices Not Going Up Fast Enough

In the September 22, 2010 article "Unusual Worry: Is Inflation Too Low? Federal Reserve Worries Prices Not Going Up Fast Enough," Associated Press economics writer Jeannine Aversa provides further evidence that the macroeconomic policy goal is LOW inflation, not NO inflation. Here is an excerpt:

The Fed, meeting for the last time before the midterm elections, said its measures show inflation is "somewhat below" desirable levels for the economy. That may sound strange, because inflation is often made out to be an economic evil.

And it can be, when it gets out of control. But its opposite can be even worse.

Once deflation takes hold, it can wreck an economy. Workers suffer pay cuts. Corporate profits shrivel. Stock values fall. People, businesses and the government find it costlier to pare debt. Foreclosures and bankruptcies rise.

And people spend less, convinced that prices will fall even further if they just wait. That trend has already emerged in the housing market. Many would-be buyers are standing on the sidelines, waiting for home prices to fall further.

Consumer Price Index News Release

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The latest Consumer Price Index news release
(http://www.bls.gov/news.release/pdf/cpi.pdf)
was issued today by the Bureau of Labor Statistics. Highlights are below.
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On a seasonally adjusted basis, the CPI-U increased 0.4
percent in November after rising 0.3 percent in October. The
index for all items less food and energy was unchanged in
November after increasing 0.2 percent in October.

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Producer Price Index News Release

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The latest Producer Price Index news release
(http://www.bls.gov/news.release/pdf/ppi.pdf)
was issued today by the Bureau of Labor Statistics. Highlights are below.
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The Producer Price Index for Finished Goods rose 1.8 percent in November, seasonally adjusted.
This increase followed a 0.3-percent advance in October and a 0.6-percent decrease in
September. The index for finished goods less foods and energy rose 0.5 percent in November.

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For help, email news_service@bls.gov
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The Christmas Price Index measures inflation using the items in the song "The Twelve Days of Christmas."

In the November 20, 2009 article "'12 Days of Christmas' items' cost would top $87K," Associated Press writer Dan Nephin reports the 2009 update of the Christmas Price Index which measures inflation using the items mentioned in the famous song as the basket of goods.

PITTSBURGH – Making one's true love happy will cost a whopping $87,403 this year, a minuscule increase from last year, according to the latest cost analysis of the items in the carol "The Twelve Days of Christmas."

That's the grand total for the single partridge in a pear tree to the 12 drummers drumming, purchased repeatedly as the song suggests, according to the annual "Christmas Price Index" compiled by PNC Wealth Management. The price is up a mere $794, or less than 1 percent, from $86,609 last year.

The cost of buying each item just once is increasing this year to $21,466, up 1.8 percent from last year's $21,081.

Jim Dunigan, managing executive of investment for PNC Wealth Management, which has been calculating the cost of Christmas since 1984, attributed the modest increase to lower energy costs and fewer wage increases.

It's the smallest increase since 2002, when the cost actually decreased, according to PNC.

The main driver behind the higher cost is that the price of gold has increased 43 percent, bringing the five gold rings up $150 to $500.

Although wage increases were modest, nine ladies dancing, at $5,473 per performance, is the costliest item, surpassing that of any of the material goods.

The most expensive goods are the seven swans a-swimming at $5,250, but their cost decreased 6.3 percent from last year's $5,600. Dunigan said their cost tends to be the most volatile because of supply and demand; they were up 33 percent last year over 2007.

Costs for the 10 lords a-leaping ($4,414 per performance), 11 pipers piping ($2,285 per performance) and 12 drummers drumming ($2,475 per performance) remained the same as last year. Dunigan says that reflects the labor market in which the unemployment rate rose to near 10 percent after sitting below 5 percent for much of the decade.

And for those who would shop online, a word of caution.

PNC says you'll pay $31,435, which is down from last year's online price, but still about $10,000 more than in the traditional index.

"In general, Internet prices are higher than their non-Internet counterparts because of shipping costs for birds and the convenience factor of shopping online," Dunigan said.

PNC Financial Services Group Inc. checks jewelry stores, dance companies, pet stores and other sources to compile the list. While it is done humorously, PNC said its index mirrors real economic trends.

Besides putting out the list for fun, PNC makes it available to teachers across the country to teach economic trends.

While it's unlikely anyone would buy the items, Dunigan said one item is likely to please.

"We don't necessarily suggest picking just one, but it's hard to believe that gold rings wouldn't lead the list on a year-to-year basis," Dunigan said.
___
On The Net:
PNC Christmas Price Index: http://www.pncchristmaspriceindex.com

Why it doesn't feel like prices are falling

In the October 26, 2009 CNNMoney article "Consumers have trouble finding falling prices," Chris Isidore asks "the government says we're paying less for our everyday needs — so where are the savings?"

The government says consumers are paying less for their everyday needs compared to a year ago. But if it feels like your dollar is not going as far as it used to, you're not alone.

The Consumer Price Index is down 1.3% from a year ago, meaning that the typical market basket of goods and services should be costing you that much less.

But there are a number of factors, some having to do with how CPI is calculated by the Labor Department's Bureau of Labor Statistics (BLS) and some having to do with economic behavior, which can make those savings seem like a mirage.

Here are some of the reasons why your wallet isn't feeling any fatter.

Fuel

Nothing has driven down overall prices more in the past year than the drop in energy prices. Gasoline prices are down nearly 30% in the past 12 months, but if you strip out falling energy prices, the overall CPI is up 1.2%.

But even though gas may be cheaper than a year ago, it still probably feels like prices are going up. That's because gas prices are up 29% in the last six months.

That obviously can cause a squeeze on household budgets, especially as a weak labor market has resulted in tiny rises in the average weekly paycheck.

Health care

Health care is a significant part of consumers' expenditures, topping money spent on gasoline and trailing only housing and food. But calculating the cost of health care is perhaps the trickiest part of CPI, partly because insurance distorts how consumers pay for medical expenses.

According to the Labor Department, overall health care costs were up 4.2% in 2008. For those calculations, the BLS surveyed consumers, medical providers and insurers and tries to come up with a specific cost of medical care.

One reason that healthcare prices appear to have only increased slightly is because if something is judged to be an improved service, such as a new drug, the BLS does not actually consider the higher costs to be a price increase.

That's because the BLS assumes consumers are getting more for their money. But new drugs and treatments are common in the medical industry -- and insurers often charge consumers more for them.

But other calculations show health care expenses, including insurance and other out-of-pocket costs, are rising faster. For example, consumers spent 7% more on health insurance in 2008 than they did a year earlier, according to a separate government reading conducted by the Census Bureau.

And surveys from the Kaiser Family foundation found rises in deductibles, co-payments and other out-of-pocket medical expenses not being captured in either the Census figure or the CPI calculations.

Blame it on Washington

Some government payments, such as Social Security benefits, are pegged to CPI. The current year-over-year decline in CPI means that those benefits won't go up next year. That will be the first time since the cost-of-living adjustment was put in place in 1975 that retirees won't get an increase in Social Security.

Tax brackets and deductions also are pegged to CPI, meaning higher tax bills for many people in 2010 than they would have had to pay if prices were higher.

In the 1990's, then Federal Reserve Chairman Alan Greenspan argued that CPI was higher than justified by economic reality and costing the government money it couldn't afford. As a result, changes in the calculation of CPI were made.

One of the most significant changes was that the government started to assume that if the price of a good rose more than the price of an alternative product, consumers would shift more of their purchases to the lower priced option, limiting the price increase. But even if consumers behave that way, they would still be aware of the higher prices of the goods they can no longer afford.

Because the federal government benefits from lower inflation readings, critics accuse policymakers of intentionally calculating CPI much lower than it should be. Even the BLS admits CPI would be between 0.2 and 0.3 percentage points higher today if the old methods had been used.

Perception

Finally, it's very likely that consumers pay more attention to prices that are going up than prices that are going down.

Behavioral economists say people are very sensitive to any financial losses, meaning they will make far more effort to avoid losing or spending money than they will to make the same amount of money.

Robert Frank, a leading behavioral economist at Cornell University, said this well-documented theory is the reason that higher prices make so much more of an impression than the lower prices that might balance it out.

"Price declines don't register with the same intensity as price increases," he said. "Even if they notice it, it's just not going to arouse them in the same way a price increase will. People like to complain."

The fact that overall price decreases aren't keeping up with the record drop in household wealth over the past few years also makes consumers that much more concerned about prices that are rising.

Frank added that with wages flat and credit still tight, products that might have been considered affordable in the past may now be out of reach for consumers -- even if prices are only up slightly.

"Any struggle to make their budgets fit just exacerbates any injuries you feel from the prices that do increase," he said.

514K new jobless claims; inflation remains muted

In the October 15, 2009 article "514K new jobless claims; inflation remains muted," Associated Press economics writer Christopher S. Rugaber reports:

WASHINGTON – New jobless claims dropped to the lowest level since January and the prices of many household goods stayed low last month, positive signs of stability for the fledgling economic recovery.

The decline in jobless claims shows companies are cutting fewer workers, though the drop isn't yet steep enough to signal new hiring, economists said. And the low level of inflation is holding down prices as Americans slowly regain their appetite to shop despite rising unemployment and tight credit conditions.

The Labor Department said Thursday that first-time claims for jobless benefits dropped to a seasonally-adjusted 514,000 from an upwardly revised 524,000 the previous week. The fifth decline in six weeks was below Wall Street economists' forecasts, according to Thomson Reuters.

The four-week average, which smooths fluctuations, fell for the sixth straight time to 531,500. That's the lowest since January and about 125,000 below the peak reached in early April.

Economists closely watch initial claims, which are considered a measure of layoffs and the willingness of companies to add jobs.

"Claims are not yet low enough to indicate rising payrolls, but they certainly suggest" that net job cuts will be lower in October than last month, Ian Shepherdson, chief U.S. economist at High Frequency Economics, wrote in a note to clients.

The tally of people continuing to claim benefits dropped by 75,000 to 5.99 million, its first time below 6 million since the week of March 28. Continuing claims data lags initial claims by a week.

Many economists expect that job losses will fall below 200,000 in October from 263,000 in September. That's still a large amount, but would be the lowest total since August 2008.

In a separate report, the Labor Department said consumer prices rose 0.2 percent last month, matching analysts' expectations. Prices excluding the volatile energy and food categories also rose 0.2 percent, slightly higher than the 0.1 percent increase analysts had forecast.

Over the past 12 months, consumer prices fell 1.3 percent, reflecting a severe recession that has kept a lid on inflation across a wide range of products and services. Excluding food and energy, prices rose 1.5 percent.

Food costs slipped 0.1 percent in September, reflecting lower prices for meat and fresh vegetables. Clothing prices rose only 0.1 percent, and housing costs were flat compared with August.

Gas prices rose 1 percent, though they are down 21.6 percent from last year when prices at the pump moved above $4 per gallon in the summer.

The lack of inflation has given Federal Reserve policymakers the room to leave interest rates at a record low near zero since December in an effort to give the economy a boost.

The absence of price pressures also has been good news for cash-strapped households, but it means no cost-of-living increase next year for the more than 57 million Americans receiving Social Security and other government benefits, the first time that's happened in over 30 years.

However, President Barack Obama on Wednesday urged Congress to provide a one-time payment of $250 to help senior citizens cope with the absence of higher benefit checks next year. Such a payment would cost the government about $13 billion.

The stock market fell in morning trading. The Dow Jones industrial average lost about 15 points, and broader indexes also slipped. The decline pushed the Dow to the 10,000 mark that it had topped Wednesday for the first time in a year.

Employers have eliminated a net total of 7.2 million jobs since the recession began in December 2007, sending the unemployment rate to a 26-year high of 9.8 percent.

Despite the improvement, the more than 500,000 jobless claims remain above the roughly 425,000 that many economists say would indicate the economy is adding jobs.

Many recipients have moved onto extended benefit programs. Congress has added about 53 weeks of emergency benefits on top of the 26 weeks typically provided by states. When extended programs are included, a total of 8.87 million people received benefits in the week ending Sept. 26, the latest week data is available. That's down about 40,000 from the previous week.

Meanwhile, businesses that received federal contracts under the Obama administration's $787 billion economic stimulus are reporting more than 30,000 jobs saved or created in the first months of the program.

The numbers released by a government watchdog Thursday only reflect jobs linked to federal contracts, such as construction at military bases or within national parks. Broader data won't be available until late this month.

The reports come as consumers are showing some signs of life. Retail sales fell in September due to a sharp drop in auto sales, according to a government report Wednesday. But excluding autos, sales rose 0.5 percent in September. That was better than analysts expected and followed a 1 percent gain in August.

Auto sales had been inflated in August by the government's Cash for Clunkers program, which provided $4,500 rebates to consumers who traded in older vehicles for newer, more fuel-efficient models.

Consumer demand, which accounts for 70 percent of total economic activity, is being watched closely by economists who worry that any recovery from the recession could stall due to rising unemployment, tight credit and other headwinds that households still face.

Most economists forecast the economy will grow at about a 3 percent pace in the second half of 2009. But they warn that won't be fast enough to bring down the unemployment rate. Fed Chairman Ben Bernanke has said that even with 3 percent growth, the jobless rate will remain above 9 percent through next year.

Some companies are still shedding workers. Ebay Inc. said Wednesday that it would lay off several dozen employees as part of an internal restructuring.

Among the states, Pennsylvania had the largest increase in claims, with 3,618, which it attributed to layoffs in the construction, primary metals, furniture and food industries. The next largest increases were in Washington, Wisconsin, Missouri and Texas. The state data lag initial claims by one week.

Florida reported the largest drop in claims, with 5,178, which it attributed to fewer layoffs in the construction, service and manufacturing industries. California, Tennessee, Illinois and Arkansas had the next largest drops.

The Economic Lesson of Goldilocks and the Three Bears: Overall Spending Should Not Be Too Large or Too Small

One of the most significant determinants of a country's economic well-being is overall spending on newly produced goods and services, which economists call aggregate demand (AD). Overall spending needs to be large enough to keep unemployment low, yet small enough to keep inflation low. Aggregate demand should not be too large or too small. Like the porridge, chair, and bed in the story of Goldilocks and the Three Bears, an economy's overall spending needs to be "just right."

Insufficient overall spending causes economic recessions and depressions. As aggregate demand declines, businesses sell fewer goods and services. Inventories of unsold products increase, leading to fewer factory orders for newly produced goods. Businesses lay off workers as production and sales decline. The unemployment rate increases as more workers become unemployed. The rate of economic growth, which is measured as the percentage change in output, decreases.

Excessive overall spending causes inflation, which is a general increase in the price level. During periods of inflation, the prices of most goods and services are rising. Inflation is similar to the rising prices of scalped tickets to a popular concert or sporting event. If a society tries to buy more goods and services than the economy is able to produce, the prices of most things will increase.

If society wishes to manage the natural fluctuations in economic activity, called business cycles, it needs to alter overall spending on newly produced goods and services. Thus, there can be a role for government in managing the economy when the consumption and investment actions of households and businesses fail to provide socially desirable outcomes.

When low unemployment and increasing inflation suggest the productive capacity of the economy is unable to meet the demand for goods and services, the appropriate policy is to discourage spending through contractionary monetary policy (higher interest rates, fewer bank loans, and a smaller money supply), and contractionary fiscal policy (higher taxes and reduced government purchases).

However, when unemployment is relatively high and economic growth is small (such as in the current recession), the appropriate policies to pursue are expansionary monetary policy (lower interest rates, more bank loans, and a larger money supply) and expansionary fiscal policy (lower taxes and increased government purchases).

In the current U.S. economy, monetary policy has been largely ineffective. Interest rates are about as low as they can go. (The federal funds rate is 0.25%. It is almost zero.) Because of the financial crisis, banks are reluctant to lend money. Tax cuts have been largely ineffective as well. Studies show most recipients have used the additional funds to pay down debt rather than increase purchases. So that leaves increased government spending as the most viable way to increase the aggregate demand for newly produced goods and services.

Thus, the economic justification for government spending programs to stimulate the economy is that they can increase aggregate demand when consumers and businesses and unwilling to do so.

If one's primary concern is economic recovery, then the spending should be done as quickly as possible on projects that employ workers in the production of new goods and services. However, there is a tradeoff between projects that can be done quickly, and those that provide the greatest long-term benefit. This has led to criticism of U.S. government stimulus spending. Projects that can be done quickly are criticized for lacking long-term benefit. Spending for more worthy projects is criticized because it is not helping the economy quickly enough. This is why defenders of stimulus programs argue we need to give them more time. Much of the spending was designed to help over the period of several years, not a few months.

CLICK HERE to read the story of Goldilocks and the Three Bears.

Consumer Prices Hold Steady, Easing Inflation Fears

According to the August 15, 2009 New York Times article Consumer Prices Hold Steady, Easing Inflation Fears, Jack Healy reports that consumer prices were relatively steady in July 2009:

Consumer prices in the United States were steady last month, easing concerns for now that the record deficit and huge new government spending would spur inflation.

“It could be a very large long-run problem,” said Mickey Levy, chief economist at Bank of America. “But in the near term, it’s not a problem at all.”

The drift in prices suggests that enormous slack remains in the American economy, even as the recession bottoms out and some industries restart production. Retail sales are sluggish, 14.5 million people are unemployed and many factories and other businesses are still running below capacity.

The Labor Department reported Friday that its Consumer Price Index was unchanged from June on a seasonally adjusted basis, and that prices this summer were 2.1 percent lower than last July, when soaring oil costs drove gasoline to $4 a gallon and lifted the cost of food and other products.

The drop in the last year has been the largest in almost 60 years, occurring as the global economic crisis reduced demand for many goods and services.

“The inflation story was nonsense in an environment where you have such wild excess capacity globally,” said Robert Barbera, chief economist at ITG, an investment advisory business. “I think inflation is below 2 percent for the next two years.”

In another hopeful sign for the economy, the Federal Reserve reported on Friday that industrial production in the United States rose last month, suggesting that manufacturers and major industries were ramping up assembly lines and increasing output.

The monthly increase of 0.5 percent was the first since October, when production rebounded after Hurricane Ike as refineries and other industries came back on line. Before that, industrial production had not posted a gain since December 2007, the first month of the recession.

Economists had expected no change in consumer prices in July. Excluding volatile food and energy prices, the so-called core rate of inflation rose 0.1 percent, also in line with expectations.

“For all the inflation fear-mongering, the fact remains that prices have, in the near term, declined further rather than turned upwards,” Dan Greenhaus, chief economic strategist at Miller Tabak, said in a research note. “Such price action comes despite, among other things, a $787 billion stimulus package and $1.75 trillion in asset purchase by the Federal Reserve.”

Some economists and investors have warned that the government’s rescue plans and big stimulus spending will stoke inflation as the economy heals, setting off worries about the strength of the dollar and rising interest rates.

But economists said that Friday’s numbers showed that inflation remained subdued even as oil prices more than doubled since February and interest rates on government bonds crept back from record lows.

The Federal Reserve, in its statement on Wednesday after its two-day meeting, said it expected “that inflation will remain subdued for some time.”

In July, retail prices for food and beverages fell 0.2 percent from a month earlier while gasoline prices declined 0.8 percent. Housing costs fell 0.2 percent for the month, and were down 0.7 percent from last year.

The cost of clothing actually rose 0.6 percent, mostly because of increases in the price of shoes and women’s apparel.

Transportation and health care costs edged up 0.2 percent.

Consumer prices jump 0.7 percent in June

According to "Consumer prices jump 0.7 percent in June":

By MARTIN CRUTSINGER, AP Economics Writer
July 15, 2009

WASHINGTON – The government says consumer prices shot up in June by the largest amount in 11 months, reflecting the biggest jump in gasoline prices in nearly five years.

The Commerce Department said Wednesday that inflation at the consumer level rose by 0.7 percent last month, slightly higher than the 0.6 percent increase that economists were expecting. It was the biggest one-month gain since a similar 0.7 percent increase last July.

The big jump was seen as a temporary blip, however. Inflation is not expected to be a problem any time soon given a severe recession which is keeping a lid on wage pressures.

Inflation creeps upward

A July 14, 2009 article, "Wholesale prices, retail sales rise in June" by Associated Press economics writer JEANNINE AVERSA reports that inflation is creeping higher:

WASHINGTON – Higher energy prices rippled through the economy in June, helping to drive a bigger-than-expected gain in retail sales.
The sharp rise in wholesale prices — as well as "core" prices that exclude food and energy — could fan investors' fears about inflation. Economists viewed the energy cost hikes as temporary and not the beginning of a dangerous bout of spiraling prices, but said consumers likely will remain cautious as the unemployment rates ticks up.
The 1.8 percent jump in the Producer Price Index, which tracks the costs of goods before they reach store shelves, came after wholesale prices rose 0.2 percent in May, the Labor Department reported Tuesday. Last month's increase was double what economists expected.
"We don't expect to see these trends stick, especially with crude oil prices coming down," said Anika Khan, economist at Wells Fargo. "We don't see any inflation or deflation at this point."
Many analysts expect the increase in energy prices will be short-lived and that the weak economy will restrain companies from ratcheting up prices they charge consumers.
Retail sales rose 0.6 percent last month, due mainly to higher gas prices and auto sales, the Commerce Department said Tuesday.
Still, the second straight increase in retail sales may be a sign that the economy is on the verge of a rebound. Americans spending more for the rest of this year should help end the longest recession since World War II, but economists maintain that any recovery will be slow.
Over the past 12 months, wholesale prices have actually fallen 4.6 percent.
Stripping out volatile food and energy prices, all other prices rose a bigger-than-expected 0.5 percent in June, the most since October. In May, the core prices dipped 0.1 percent. Economists expect a bump-up in core prices of just 0.1 percent last month.
For the 12 months ending in June, core prices rose 3.3 percent.
In June, energy prices jumped 6.6 percent. Gasoline prices increased 18.5 percent, home-heating oil 15.4 percent and liquefied petroleum gas, such as propane, went up 14.6 percent. All were the biggest increases since November 2007.
Crude oil prices topped $72 a barrel in June but have eased since then. Oil prices hit a record-high of $147 a barrel last July.
Food prices also rose sharply in June. They posted a 1.1 percent gain, after falling 1.6 percent in May.
A 21.8 percent jump in the price of vegetables led the way. Prices for eggs and young chickens also fed the increase in overall food prices as did a record 3.6 percent increase in the price of bottled carbonated soft drinks. The prior record price increase of 2.7 percent in that category came in January 1998.
Higher prices for cars, trucks, furniture and pharmaceutical preparations factored into the pickup in "core prices" in June. Economists blamed higher energy costs for spilling over and helping to push up the prices of other goods. They believe this will reverse as energy prices moderate.
On Wall Street, stocks dipped despite strong earnings reports from Johnson & Johnson and Goldman Sachs Group Inc. The Dow Jones industrial average lost about 15 points in late-morning trading, while broader indices also edged down.
Meanwhile, businesses cut inventories for the ninth consecutive month in May, as companies continued to trim stockpiles amid the recession.
The Commerce Department said inventories fell 1 percent in May, a bit worse than the 0.8 percent drop economists expected. Total business sales dipped 0.1 percent in May, led by a 0.9 percent drop in sales by manufacturers.
To battle the recession, the Federal Reserve has slashed a key banking lending rate to a record low near zero. It is expected to hold the rate there through the rest of this year to help support the economy and because the central bank doesn't foresee inflation getting out of hand.
Fed Chairman Ben Bernanke and many private economists predict the recession will end later this year. However, they warn that the recovery will be slow. That means the unemployment rate, now at a 26-year high of 9.5 percent, will keep rising, probably hitting double-digits in the months ahead.
At the Fed's last meeting in late June, policymakers dropped concerns that the recession could trigger deflation — a destabilizing and prolonged bout of falling prices and wages.
Fed policymakers did acknowledge that energy and other commodity prices had risen. But they predicted that idle factories and the weak employment market would make it hard for companies to raise prices. The Fed said it expects inflation will "remain subdued for some time."

Will Overstimulating Economy Bring Inflation?

The National Public Radio (NPR) story "Will Overstimulating Economy Bring Inflation?" considers the relationship between overall spending and inflation:

Morning Edition, June 26, 2009 · While the United States worries about a repeat of the Great Depression, Germans have another crisis in mind: the hyperinflation that hit them more than 80 years ago. And inflation may be on German Chancellor Angela Merkel's mind when she meets with President Obama in Washington on Friday.

Just after World War I, Germany underwent what is now the textbook case of hyperinflation. Germany had debts to pay and it had gotten into the bad habit of basically printing money. At the peak of the crisis, German currency included a 50-million-mark note.

In When Money Dies: The Nightmare of the Weimar Collapse, Adam Fergusson wrote:

"In October 1923 it was noted by the British Embassy in Berlin that the number of marks to the pound equaled the number of yards from the Earth to the sun.

"Dr. Schacht, Germany's National Currency Commissioner, explained that at the end of the Great War one could in theory have bought 500,000,000,000 eggs for the same price as that for which, five years later, only a single egg could be procured."
Some people worry the United States might be heading for inflation soon. The amount of money in an economy is determined by its central bank, which is supposed to be independent of politics.

In the current crisis, the Federal Reserve and other central banks around the world have been taking unprecedented, historic steps to make credit available — to basically push money into the economy.

The head of Germany's central bank has warned that this could lead to inflation.

Merkel earlier this month said, "We must return to an independent central bank policy, and to a policy of reason. Otherwise, in 10 years' time, we'll be in exactly the same situation."

Merkel worried the central banks might be bowing to political pressure, losing their independence.

Josef Joffe, editor of the German newspaper Die Zeit, says concern about inflation is in the German DNA. He worries there's just too much money in the economy.

"[U.S. Treasury Secretary] Tim Geithner and [Fed Chairman Ben] Bernanke and the president and [National Economic Council Director] Larry Summers think they can soak it up again when the time comes," Joffe says. "But meanwhile, they are pumping unprecedented liquidity into the American global system. And I just can only say, 'Good luck, Mr. President, in soaking up that excess liquidity.' And I think that's what Mrs. Merkel reacted to. If the Germans believe in one god, it's the independence of the central bank."

So are we at risk of catching a nasty case of inflation down the road? I took our U.S. economy in for a kind of doctor's office visit to a place that gives this advice out to countries all the time — the International Monetary Fund.

"What we have been telling ... not this country, but all our members, is that there is a need in the short run for macroeconomic policies to support economic activity. But there is a need for every central bank, for every government to have a strategy, to start thinking now about how to exit when the moment comes," says Carlo Cottarelli, the IMF's director of fiscal affairs.

There could be difficulties, he says.

Raising interest rates and pulling money back out of the economy is often unpopular. It's been said the role of a central bank is to "pull away the punch bowl, just as the party gets going." That time is arguably still in the future. As we all know, it's still a pretty lousy party.

Fed says recession easing, inflation not a threat

In the June 24, 2009 story "Fed says recession easing, inflation not a threat", Associated Press economics writer Jeannine Aversa reports the U.S. central bank left the federal funds rate unchanged because is sees signs the U.S. economy is recovering:

WASHINGTON – The Federal Reserve signaled Wednesday that the weak economy likely will keep prices in check despite growing concerns that the trillions it's pumping into the financial system will ignite inflation.
Fed Chairman Ben Bernanke and his colleagues held a key bank lending rate at a record low of between zero and 0.25 percent, and pledged again to keep it there for "an extended period" to help brace activity going forward.
Even though energy and other commodity prices have risen recently, the Fed said inflation will remain "subdued for some time." This new language sought to ease Wall Street's concerns that the Fed's aggressive actions to revive the economy will spur inflation later on.
The Fed also decided to maintain existing programs intended to drive down rates on mortgages and other consumer debt. Instead, the central bank again reserved the right to make changes if economic conditions warrant.
The Fed in March launched a $1.2 trillion effort to drive down interest rates to try to revive lending and get Americans to spend more freely again. It said it would spend up to $300 billion to buy long-term government bonds over six months and boost its purchases of mortgage securities. So far, the Fed has bought about $177.5 billion in Treasury bonds.
The Fed is on track to buy up to $1.25 trillion worth of securities issued by Fannie Mae and Freddie Mac by the end of this year. Nearly $456 billion worth of those securities have been purchased.
Fed policymakers noted that the "pace of economic contraction is slowing" and that conditions in financial markets have "generally improved in recent months." That observation about the recession was stronger than after the Fed's last meeting in April.
Economists predict the economy is sinking in the April-June quarter but not nearly as much as it had in the prior six months, which marked the worst performance in 50 years. The economy is contracting at a pace of between 1 and 3 percent, according to various projections.
Fed policymakers said its forceful actions, along with President Barack Obama's stimulus of tax cuts and increased government spending will contribution to a "gradual "return to economic growth.
Bernanke has predicted the recession will end later this year. Some analysts say the economy will start growing again as soon as the July-September quarter.
Fed policymakers noted that consumer spending has shown signs of stabilizing but remains constrained by ongoing job losses, falling home values and hard-to-get credit.
Even after the recession ends, the recovery is likely to be tepid, which will push unemployment higher.
The nation's unemployment rate — now at 9.4 percent — is expected to keep climbing into 2010. Acknowledging that the jobless rate is going to climb over 10 percent, President Barack Obama said Tuesday he's not satisfied with the progress his administration has made on the economy. He defended his recovery package but said the aid must get out faster.
Some analysts say the rate could rise as high as 11 percent by the next summer before it starts to decline. The highest rate since World War II was 10.8 percent at the end of 1982.
The weak economy has put a damper on inflation.
Consumer prices inched up 0.1 percent in May, but are down 1.3 percent over the last 12 months, the weakest annual showing since the 1950s. The Fed suggested companies won't be in any position to jack up prices given cautious consumers, big production cuts at factories and the weak employment climate.

Comparing Inflation Rates

TradingEconomics compares the inflation rates in several countries (Australia, Canada, the Euro Area, Japan, New Zealand, Switzerland, the United Kingdom, and the United States):

Inflation Rates measured by the Consumer Price Index (CPI), Year over Year (YoY)

Inflation is the rate at which the general level of prices is rising. The most well known indicator of inflation is the Consumer Price Index (CPI) which measures the average price of consumer goods and services purchased by households. High rates of inflation are often associated with fast growing economies where the demand for goods and services is higher that the country’s productive capacity. The fight against inflation is done by central banks which control the money supply by increasing or decreasing short term interest rates. For instance, the Governing Council of the European Central Bank aims at keeping annual inflation under 2% to promote price stability and sustainable growth.

(Year over year means the measurement is made in comparison to what it was at the same time in the previous year. For example, comparing the inflation rate in January 2010 with what it was in January 2009.)

U.S. Public Debt Since 1940 - Adjusted for Inflation

Here is the U.S. public debt since 1940 adjusted for inflation:

Adjusting the public debt for inflation provides a good account of federal government borrowing. The public debt increased in the 1940s to finance World War II. The public debt remained fairly constant from the late 1940s through 1981. This means the U.S. was reasonably responsible with its finances, collecting sufficient revenues to pay for government services. There is a slight increase in the 1970s. With the exception of a few years in the late 1990s, the U.S. government has increased its debt every year since 1981. Revenues have been insufficient to cover expenditures because government revenues have been reduced by tax cuts, but government spending has continued to increase. Most analysts attribute the reduction in the public debt in the late 1990s to the Congressional adoption of pay-as-you-go (PAYGO) rules. PAYGO required increases in discretionary spending to be accompanied by either tax increases or equivalent reductions in other government spending. After the election of President George W. Bush in 2000, the PAYGO rules were allowed to lapse in the House of Representatives and watered down in the Senate to facilitate the passage of tax cuts and the Medicare prescription drug plan, which former U.S. Comptroller General David Walker called "...probably the most fiscally irresponsible piece of legislation since the 1960s... because we promise way more than we can afford to keep." There was a subsequent dramatic increase in the U.S. public debt.

See also the "U.S. Public Debt Since 1940" and "U.S. Public Debt as a Percentage of Gross Domestic Product (GDP)".

Inflation - A Mind Map

Click on the image above to enlarge the mind map of inflation from dineshbakshi.com.

Low Inflation - Questions for Further Study

QUESTIONS FOR FURTHER STUDY

1. Chile experienced hyperinflation in 2005. What was the inflation rate? What caused Chile’s hyperinflation?

2. Go to the web site for the Bureau of Labor Statistics (www.bls.gov) to find historical U.S. inflation data. Is there a correlation between high inflation rates of inflation and U.S. involvement is wars? What explanation does economic theory provided for this correlation?

3. Stagflation is the economic condition of having relatively high unemployment and inflation at the same time.
(a) Since cyclical unemployment is caused by insufficient aggregate demand and demand-pull inflation is caused by excessive aggregate demand, how is it possible to have stagflation?
(b) What remedies might you suggest for stagflation?
(c) Which is the greater concern: high unemployment or high inflation?
(d) When has the U.S. economy experienced stagflation? What were its causes? How was it remedied?

Important Definitions Related to the Macroeconomic Policy Goal of Low Inflation

· Inflation is a general increase in the level of most prices in an economy.

· The price level represents the prices of most products in an economy. It is approximated by a price index, such as the Consumer Price Index (CPI), Producer Price Index (PPI), or the GDP deflator.

· The inflation rate is a measurement of how quickly prices are rising in an economy. It is typically reported as the annual percentage increase in the price level.

· Deflation is a general decrease in the price level.

· Disinflation occurs when the inflation rate decreases, but remains positive.

· Hyperinflation is extreme inflation in which the inflation rate exceeds 50% per month.

· Nominal data have not been adjusted for inflation.

· Real data have been adjusted for inflation. They are reported using prices from a common base year.

· The shoe leather costs of inflation are the wasted time and inconveniences caused when inflation encourages people to reduce their holdings of currency.

· The menu costs of inflation are the costs associated with changing the prices of the products sold by a business.

· Purchasing power is the value of the products a person is able to buy with a given amount of money.

· Indexation refers to using a law or contract to automatically correct a dollar amount for the effects of inflation.

· Cost-of-living adjustments (COLAs) automatically increase Social Security benefits to compensate for the loss in purchasing power caused by inflation as measured by the Consumer Price Index (CPI).

· Cost-push inflation is an increase in the price level caused by higher costs of production.

· Demand-pull inflation is an increase in the price level caused by excess demand for newly produced goods and services. Society’s demand for new products exceeds its ability to produce them.

· "Too much money chasing too few goods" is an expression that describes demand-pull inflation, which is an increase in the price level caused by excess demand for newly produced goods and services. Society’s demand for new products exceeds its ability to produce them.

· The quantity theory of money suggests there is a relationship between the supply of money and the inflation rate. If the money supply increases faster than an economy’s output, a likely outcome is inflation.

· A price index is an estimate of the price level that is used to measure inflation. Three commonly used price indices in the United States are the Consumer Price Index (CPI), the Producer Price Index (PPI), and the GDP deflator.

· A basket of goods is a collection of products used to calculate a price index.

· The base year is the year that is used as the comparison year when calculating an index.

· The Consumer Price Index (CPI) is a measure of the price level based on a fixed basket of the goods and services purchased by a typical urban family. It is used to calculate the inflation rate.

· The Producer Price Index (PPI) is a family of indices that measures the price level based on a fixed basket of all goods and services produced and sold by American businesses. It includes consumer products and goods and services used as inputs in the production of other products.

· The GDP deflator is a measure of the price level based on all goods and services produced in a country in a particular year. Unlike the CPI and PPI, the GDP deflator is not based on a fixed basket of goods.

The Most Important Concepts about the Macroeconomic Policy Goal of Low Inflation

· Inflation imposes costs on society that generally result in reduced economic growth and lower present and future standards of living.

· Keeping inflation low is the primary macroeconomic policy goal in the most developed economies of the world.

· Inflation can be very hard to eliminate because expectations of future price increases contribute to continued inflation.

· Inflation is most commonly measured in the U.S. using the consumer price index (CPI). The measurement of inflation using the consumer price index (CPI) exaggerates the actual level of price increases in an economy. Consequently, even when the prices of consumer products are relatively stable, the CPI suggests there is 1-2% inflation in the economy. Thus, the macroeconomic policy goal is low inflation, rather than no inflation.

U.S. Inflation Rates Since 1956

U.S. INFLATION RATES SINCE 1956
YEAR	CPI (1982-1984 = 100)	Annual Inflation Rate
1956	27.2	1.5%
1957	28.1	3.3%
1958	28.9	2.8%
1959	29.1	0.7%
1960	29.6	1.7%
1961	29.9	1.0%
1962	30.2	1.0%
1963	30.6	1.3%
1964	31.0	1.3%
1965	31.5	1.6%
1966	32.4	2.9%
1967	33.4	3.1%
1968	34.8	4.2%
1969	36.7	5.5%
1970	38.8	5.7%
1971	40.5	4.4%
1972	41.8	3.2%
1973	44.4	6.2%
1974	49.3	11.0%
1975	53.8	9.1%
1976	56.9	5.8%
1977	60.6	6.5%
1978	65.2	7.6%
1979	72.6	11.3%
1980	82.4	13.5%
1981	90.9	10.3%
1982	96.5	6.2%
1983	99.6	3.2%
1984	103.9	4.3%
1985	107.6	3.6%
1986	109.6	1.9%
1987	113.6	3.6%
1988	118.3	4.1%
1989	124.0	4.8%
1990	130.7	5.4%
1991	136.2	4.2%
1992	140.3	3.0%
1993	144.5	3.0%
1994	148.2	2.6%
1995	152.4	2.8%
1996	156.9	3.0%
1997	160.5	2.3%
1998	163.0	1.6%
1999	166.6	2.2%
2000	172.2	3.4%
2001	177.1	2.8%
2002	179.9	1.6%
2003	184.0	2.3%
2004	188.9	2.7%
2005	195.3	3.4%
2006	201.6	3.2%
2007	207.342	2.8%
2008	215.303	3.8%
2009	214.537	-0.4%
2010	218.056	1.6%
2011	224.939	3.2%

Table. Historical data for the Consumer Price Index (CPI)
and the Inflation Rate.
Source: U.S. Bureau of Labor Statistics
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

Limitations of Using the Consumer Price Index (CPI) to Measure Inflation

Limitations of Using the Consumer Price Index (CPI) to Measure Inflation

1. Prices of different products rise at different rates. Consumers tend to shift their consumption away from the more expensive products and substitute cheaper products. Because the CPI uses a fixed basket of goods, it will assume people are still buying the same amount of the relatively expensive products. In reality, however, they are buying less of the expensive products. So their overall expenses are not as large as the CPI suggests.

2. Price indexes have difficulty measuring changes in quality. Consumers benefit from higher quality products. When inflation calculations use a fixed basket of goods, however, the implicit assumption is the quality does not change. A product could be more expensive because it has improved in quality. The CPI would attribute the price rise to inflation.

3. Price indexes have difficulty including new technology. Consumers benefit from new technology, but the fixed basket of goods used in the CPI will not include the newest products and technology. Thus, the CPI is an inaccurate measure of the true cost of living of a typical urban consumer.

The CPI is the primary index used to calculate the inflation rate in the United States. Because of its shortcomings, most economists think the CPI overestimates the inflation rate by 1-2%. This is why the macroeconomic policy goal is low inflation, not no inflation. When the inflation rate is reported around 1.5%, economists feel there in very little real inflation.