Inflation 2021

Now that inflation is back in town I have been reading all the articles and thinking more about what it all means. 

It made me want to start at the beginning and that's where it gets really strange. Inflation is a very unique word. It has way too many meanings to be easy to discuss. For example, inflation can be a very general word meaning to increase in size or function. You inflate your tires and some people inflate their egos. Those meanings have very little to do with economic inflation though they share the idea that something is changing in size. Inflate means to become larger. Deflate means to get smaller.

While that first step is logical, it doesn't help us much to understand today's news.  Ok, economic inflation  is getting bigger. What exactly is inflating? How do you measure that? Once we get through all that, we ask is inflation good or bad? If it is usually bad -- then how is it ever good?

What is inflating? While my waistline is often inflating, what we mean by inflation usually has something to do with the consumer price index -- the CPI. Each month the labor department surveys a lot of stores and asks about the price being charged for the goods and services they have defined as part of the consumer's typical purchases. They average the prices of the typical consumer's "basket" of goods and services. If the average this month is higher than the average last month, they say there is inflation. If lower, they say we experienced deflation. 

Typically they also report the percentage change from one month to the next. So they might say that the inflation rate was 4% in May. If the inflation rate was 1.8% in the previous month they we would say the inflation rate increased. 

Think of all the prices out there. There are prices for new things: nondurable consumer goods (food), durable consumer goods (autos), consumer services (electricity) -- when we measure changes in those things we are mostly looking at consumer inflation. The Bureau of Economic Analysis produces a similar consumer oriented price index called the personal consumption expenditures deflator. It is very similar to the CPI but differs in several ways. They sometimes come up with different results for consumer inflation, 

There is a similar long list of non-consumer items -- that business firms buy. Like households, businesses buy food and clothing (uniforms) and energy, but they also buy tools and other equipment their workers use as well as the structures they erect, like new office buildings and plants. They also buy partially finished goods from other firms. And they may buy a host of business services like accounting and consulting. These items are often measured in wholesale price indices or in business cost indices. It might be possible that consumer prices are rising one month even though business prices are falling. Both measures are important in their own right and tell us different things about inflation. 

If households or businesses import goods or services from other countries these are factored into inflation too. Exchange rates complicate the valuations of import prices since we know that a lower (higher) dollar makes foreign items cost more (less) for any given sticker prices. 

Main point so far. Inflation comes in a lot of flavors.

A second point is that much depends on the time period you are measuring. Like your weight, inflation can fluctuate a lot on a given day. Most of the time we measure price change in months or quarters or years. The longer the interval, the more we can conclude there is a trend and that is another way of saying that it has gone on long enough to really impact us. Sometimes we ignore a big in change in inflation in one month -- preferring to wait and see what happens over the next months 

Lots of flavors. Lots of time periods. Lots to think about. 

Is a sustained increase in inflation something to worry about? Most of us think from the perspective of buyers and we usually don't like consumer price inflation. But if you sell apples and the inflation rate of apples rises, then you are probably happy. Your customers might not be so happy but at least they are getting apples. Maybe with less inflation sellers would be less willing to bring apples to the market? You see, now it is getting complicated. Is inflation good or not? 

Generally we think that inflation is like grease -- a little grease applied in the right place at the right time makes the machine work well. But too much grease can clog up the works. Inflation is similar. We don't mind a little inflation. As a firm, it's nice to think that your prices are rising. As a worker, rising goods prices often bring higher wages and incomes. But when inflation starts jumping around and rises in leaps and bounds, then it drives us crazy. When the average increase in each month goes up for several months, then we start to get concerned. 

So that's a little ditty about inflation. At the moment, we have seen some large one-month changes. While that gets our attention it does not mean the large changes will continue in the future and it does not mean that higher inflation is sustainable. It does mean that we need to look into it more and make sure that policy is not making it worse.