Dan Sutter: The pain of inflation
Inflation is a top concern of voters. Yet economists generally argue that the costs of inflation are exaggerated. Can we reconcile these views? To begin, inflation as measured by the Consumer Price Index (CPI) has fallen significantly since hitting 9.1 percent in June 2022. Inflation was 7 percent for all of 2022 but only 2.9 percent in July. Remember also that inflation is the rate of change in prices. A decline in inflation means that prices are increasing slower. To return prices to 2021 levels would require negative inflation, or deflation. Economists normally think about a “pure” inflation, or equal percentage increases in all prices, including wages and salaries. Five percent inflation then is a five percent increase in the prices of all goods, services, and labor. The increase in wages should offset the higher prices (ignoring tax impacts). An increase in the prices of only some goods is a change in relative prices. A ten percent price increase for food, energy, and transportation might increase the CPI by five percent. This is not, strictly speaking, inflation and since wages do not rise, people will be worse off. I think economists should focus on how inflation impacts families. Understanding decisions as viewed by the subjects of our analysis is a core element of economic research. The CPI measures the cost of purchasing an average market basket of goods which no household probably buys. The effective inflation rate for households depends on the things they buy. Today some face more than 2.9 percent inflation. Raises do not come automatically with price increases except with a COLA or Cost of Living Adjustment. COLAs adjust wages or salaries as the CPI rises. Social Security benefits get COLA adjustments, but only about one in ten private sector employees have COLAs. Consequently, most workers are not guaranteed an offsetting raise. Inflation therefore generates uncertainty, which is stressful. Also, many Americans’ “raises” came from changing jobs, which entails its own costs and stresses. An offsetting raise, if received, comes after prices rise. Monthly budgets were still stressed during 2022 even for those receiving a seven percent raise at year’s end. Wages generally lag prices in the inflation race. Many Americans do not save annually and have little accumulated savings. Higher prices for essential items create hard decisions. Most economists can afford an extra $100 a month for groceries without a raise. We fail to recognize the burden higher prices impose on many families. A change in calculating the CPI may heighten the divergence between measured and felt inflation. Substitution bias contributed to the CPI overstating the inflation rate. The CPI market basket does not change monthly as prices rise and fall, but consumers will respond. To illustrate, suppose Coke and Pepsi initially sell for $4 a bottle. The price of Pepsi rises to $6 while Coke stays at $4, a 25 percent increase in the average soda price. The impact on consumers is less than the 25 percent increase resulting from both prices rising to $5. Many will substitute Coke for Pepsi here. Beginning in 1999 the Bureau of Labor Statistics began adjusting the CPI for substitution bias, which makes sense. But consumers miss out on some satisfaction even if substitution keeps budgets from busting. A final consideration involves the COVID and lockdown supply chain disruptions. Shortages create significant economic pain, in several ways. To see how, during the baby formula shortage, desperate parents drove from store to store. The time and gas spent searching increase the effective price of formula when finally purchased. Items not consumed reduce consumer satisfaction. And shortages produce uncertainty. The prices necessary to keep some items in stock provide a way to value the impact of shortages. Measured inflation if prices had risen like this would have significantly exceeded seven percent. To be precise, this pain is due to the shortages and not inflation. But people likely associate it with recent inflation. A simultaneous equal percentage increase in all prices and wages might not be very painful. But that’s not how inflation works. Recognizing the felt pain illuminates Americans’ concern with inflation. Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.
Prices in the South rise again in August
Prices in the South Region increased for the second consecutive month in August, according to data released by the U.S. Bureau of Labor Statistics on Wednesday. The Consumer Price Index for all urban consumers in the South bumped up 0.6% in August, bringing inflation over the past year to 4.1%. The rising prices were fueled in large part by a 3.8% increase in the energy index since July; gas prices increased 7.2%. All items less food were up 0.3%, while food was up 0.2% The overall monthly increase is the largest since April and the third largest so far in 2023, growing three times faster than July’s 0.2% increase. The index for all items less food and energy is up 4.8% since August 2022, while food is up 4.6%, and the energy index has declined 2.2% since that time. “The CPI is based on prices of food, clothing, shelter, fuels, transportation fares, charges for doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living,” according to the BLS. “Each month, prices are collected in 75 urban areas across the country from about 6,000 housing units and approximately 22,000 retail establishments – department stores, supermarkets, hospitals, filling stations, and other types of stores and service establishments. All taxes directly associated with the purchase and use of items are included in the index.” The South, as defined in Census regions for the report, includes Alabama, Arkansas, Delaware, District of Columbia, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, Oklahoma, South Carolina, Tennessee, Texas, Virginia and West Virginia. The biggest increases in the index for the South Region over the last year have come from a 13.3% jump in transportation services and an 8.5% increase for shelter, while the biggest declines came from a 14.9% drop in piped gas prices and a 6.8% decline for used cars and trucks. A Cygnal poll of 600 North Carolinians conducted on behalf of the right-leaning John Locke Foundation Aug. 20-21 found more than 95% have noticed the increase in food prices, which just over 61% attribute to increased fuel and energy costs. Another 44% cited government policies, while 36% blamed supply chain disruptions. Nearly 66% of those polled agreed that “government regulations have caused strain in the American food system, leading to higher food prices.” The uptick in the South’s consumer price index comes as many economists predict the Federal Reserve will hold interest rates steady when it meets next week following increases from just above 0% in 2022 to 5.25-5.5% now – the highest level since 2001. Republished with the permission of The Center Square.
Majority of Americans say they are ‘falling behind’ rising cost of living
The majority of Americans feel they cannot keep up with the cost of living as inflation and the price of goods continue to rise, according to new polling data. A poll from NBC News asked Americans, “Do you think that your family’s income is … going up faster than the cost of living, staying about even with the cost of living, or falling behind the cost of living?” In response, 65% said they are falling behind, and 28% said they are staying about even with the cost of living. Only 6% said their income is going up faster than the cost of living.” The poll comes amid soaring inflation and gas prices. U.S. gasoline prices hit another record high Monday, with Americans paying $4.48 per gallon average for a gallon of regular gasoline. Gas prices have risen about 40 cents in the past month alone. The average price per gallon was $3.04 a year ago, a $1.44 increase. The latest inflation data has also shown a significant rise in prices since President Joe Biden took office, with price increases outpacing wage gains. Consumer prices have risen at the fastest rate in decades. “The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in April on a seasonally adjusted basis after rising 1.2 percent in March…” the Bureau of Labor Statistics says. “Over the last 12 months, the all items index increased 8.3 percent before seasonal adjustment.” Biden has defended his work on the economy, pointing to the jobs recovered since the pandemic. Republicans, though, point to inflation and problems with the labor market. “As Americans face record-high prices at the pump, President Biden is continuing his war on American energy by canceling oil and gas leases in Alaska and the Gulf of Mexico,” said Rep. Kevin Brady, R-Texas. “Working families are already suffering from Biden’s inflation crisis and harmful policies.” Republished with the permission of The Center Square.
Dan Sutter: Greed and inflation
Inflation topped 7 percent in December, the highest level in forty years. The Biden administration has tried blaming rising prices on corporate greed with antitrust enforcement as a remedy. Does this make economic sense? We must first consider what inflation is. Measured by the rate of change in the Consumer Price Index (CPI), economists define inflation as increasing the general price level. Increases in the prices of some goods with others remaining unchanged raises the CPI but are changes in relative prices. Relative price changes result from changed economic conditions like with lumber in 2020. A “pure” inflation is an equal percentage increase in all prices, including wages and salaries. Inflation also involves an expectation of continued price increases. Pandemic-related production disruptions might cause price increases but not continued increases; prices should stabilize once production resumes and backorders are filled. Is the last year’s CPI increase due to relative price changes or true inflation? We clearly have had some relative price increases for things like lumber and new and used cars (37 percent price increase over the past 12 months). But many CPI components have increased by five or six percent. Most prices are rising. Interest rates provide the best gauge of future inflation. They are based on the decisions of thousands of persons, each investing their own money and superior to any expert’s forecast. Florida Atlantic University economist Will Luther calculates that the bond market currently forecasts 2.6 (2.2) percent annual inflation over the next five (ten) years. Markets expect inflation to moderate but not disappear. Now we can turn to greed and antitrust. I will not distinguish between greed and self-interest here. Economists assume everyone acts in their self-interest. For businesses, this means selling for the highest prices possible, but consumers must voluntarily purchase what businesses want to sell, and competition between sellers limits prices. Greed only explains rising prices if competition has been reduced. State business closure orders during COVID helped bankrupt thousands of small businesses. Yet the impact of these failures on the overall level of competition is likely modest. Furthermore, reduced competition would likely generate a one-time price increase; with less competitive pressure, a business might raise prices by five percent. Since greed is not causing inflation, more aggressive antitrust enforcement will not stop inflation. Economists across the political spectrum recognize this. Larry Summers, former Secretary of the Treasury under President Bill Clinton, said on Twitter: “The emerging claim that antitrust can combat inflation represents ‘science denial.’” Precedent exists for using inflation fears to justify unrelated policies. Until the 1970s, Washington regulated railroads, trucking, and airlines. This was not just safety regulation but control of the number of firms, routes of operation, and prices. Economic research documented the harms of this regulation: higher prices, reduced productivity, and poorer transportation options. The principle of concentrated benefits and dispersed costs from public choice economics explained the persistence of such regulations. The companies and their unions, including the powerful Teamsters, benefited from regulation. Consumers faced an enormous total cost but small individual costs. Regulation was crucial to the industry but a minor issue for consumers. Then something amazing happened. America faced high inflation, and Senator Edward Kennedy sought an issue to boost his presidential hopes. Future Supreme Court Justice Stephen Breyer was on the Senator’s staff and knew about the economic research. Senator Kennedy held widely publicized hearings touting deregulation to offset the pain of inflation. President Jimmy Carter got on board, and by 1980, all these industries were deregulated. Attributing causality is virtually impossible in public policy. But most histories of deregulation cite Senator Kennedy’s hearings as highly important in the process. Deregulation as a cure for inflation is economic silliness. Yet confusion over-inflation may have enabled beneficial policy change. Policymakers, I suspect, remember this lesson. Expect politicians to try selling their pet projects as fighting inflation. But as economist Milton Friedman famously said, “Inflation is everywhere and always a monetary phenomenon.” Alleged inflation remedies should be evaluated on their own merits. Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.
Daniel Sutter: The battle against inflation
Inflation fears rose briefly during 2018, as the increase in the Consumer Price Index (CPI) approached 3 percent. In 1980, three percent annual inflation would have set off celebrations. Our success in reducing inflation provides a lesson about policy making by elected officials. To avoid confusion we should be clear about the meaning of inflation. Americans often mean the cost of living when they say inflation. Economists, by contrast, specifically mean an increase in the overall price level. A pure 5 percent inflation would be exactly a 5 percent increase in every price. Salaries and wages are prices and would be included. Inflation should not reduce the ability of households to buy goods and services, as income and expenses both increase equally. Economists call an increase in the price of gasoline or housing a change in relative prices, not inflation, even though either raises living costs. Housing costs more in New York or San Francisco than in Alabama. That the cost of living in Manhattan is more than double that in Montgomery matters for weighing job offers. Differences in living costs, however, are also not inflation. The CPI does not include wages and rises even for relative price increases, yet still measures inflation pretty well. The annual change in the CPI exceeded 10 percent in 1974 and 1979-1981, hitting 13.5 percent in 1980. By 1983, inflation was below 5 percent and has only topped this level once since. The U.S. has not been the only nation to bring inflation under control. U.S. inflation fell from 8.5 to 1.7 percent over 1974-83 and 2008-17. Yet over these decades, inflation fell from 11.3 to 1.1 percent in France and from 16.7 to 1.1 percent in Italy and Spain. Even Latin America has experienced progress; inflation fell from 33 to 4 percent in Mexico and from 112 to 6 percent in Brazil. International success argues against a uniquely American explanation for our decline in inflation. For instance, I might wish to credit Ronald Reagan for defeating inflation. While President Ronald Reagan undoubtedly deserves some credit, a “great person” story would require great leaders in many nations, which seems less likely. During the 1970s, many blamed inflation on rising world oil prices. A decline in oil supply would raise oil prices and hike the CPI, but would be a relative price change, not inflation as defined by economists. And significant oil price increase last decade did not produce double digit inflation. One economist who never wavered about the cause of inflation during the 1970s was Milton Friedman, who insisted that “inflation is everywhere and always a monetary phenomenon.” Governments and their central banks, like our Federal Reserve, inflate the money supply, driving up prices. Behind the focus on oil, the Federal Reserve did indeed fuel the 1970s inflation with money supply growth. With Paul Volcker as Federal Reserve Chair and Ronald Reagan in the White House, the brakes were put on the money creation and inflation fell accordingly. The economics profession now largely accepts that Professor Friedman was right on inflation. Why then did so many nations cause themselves the pain of inflation? And what has changed? Monetary economists have identified central bank independence as a key. A central bank is like a bank for the nation’s banking system, and generally controls the money supply. Politicians find easy money and credit irresistible, particularly when running for reelection. If politicians have too much control, they will inevitably inflate the money supply. The Federal Reserve has always had some political independence. When the Fed Chair and Governors want monetary stability, as Mr. Volcker and his successor Alan Greenspan did, they can often prevail over the President and Congress. Other nations increased their central banks’ independence, based on economists’ advice. The European Central Bank was modeled on Germany’s independent Bundesbank. People are imperfect and face problems of self-control. Our elected officials are human, and the potential to shift blame in politics exacerbates self-control problems. The world’s success battling inflation shows that elections alone do not always ensure wise economic policy. Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.
