Co-blogger David Henderson usefully mentioned the publication of an interesting book edited by Ryan Bourne, The War on Prices. The authors, of which I am honored to be part, also include Brian Albrecht, Pedro Aldighieri, Nicholas Anthony, David Beckworth, Ryan Bourne, Eamonn Butler, Vanessa Brown Calder, Michael Cannon, Jeffrey Clemens, Bryan Cutsinger, Alex Edmans, Peter Jaworski, Deirdre McCloskey, Jeffrey Miron, Liya Palagashvili, Joseph Sabia, J. R. Shackleton, Peter Van Doren, and Stan Veuger. The book provides a wide-ranging review of the essential role of prices. (By initiating and coordinating this effort, Ryan achieved a remarkable feat.)
My own article, titled “A Rising Product Price Doesn’t Cause Inflation” (pp. 19-27), focuses on the crucial distinction between relative prices and inflation. A few excerpts:
We must clearly distinguish the two different phenomena: relative price changes and changes in the general level of prices.
A relative price is the price of one good in relation to the price
of another.Inflation is an increase in the price of all goods in terms of money.
The general price level (and thus inflation) is not technically observable as such and must be estimated, typically through some weighted average of observed individual prices, like in the CPI. But we must keep in mind the difference between what we are attempting to measure and its calculated estimate.
In the presence of inflation, the change of a given price will include both its relative change (without inflation) and the effect of inflation.
If an observed price—say, the price of roast beef or of gasoline—comes from both a relative price change and inflation, the observed price cannot cause inflation.
The CPI and similar indexes can be useful indicators of, or alerts to, inflation, but only if we realize their inherent limitations.
It is important to realize that inflation is a monetary phenomenon that has nothing to do with the supply-chain fetish. The misleading supply-chain explanation provides an excuse for central governments to inflate the money supply in order to finance their self-interested interventions.
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The supply-chain fetish, by DALLE-E and Pierre Lemieux
READER COMMENTS
Craig
May 15 2024 at 11:16am
“It is important to realize that inflation is a monetary phenomenon that has nothing to do with the supply-chain fetish. The misleading supply-chain explanation provides an excuse for central governments to inflate the money supply in order to finance their self-interested interventions.”
Any other conclusion should be considered a type of heresy. Indeed in a recent video clip of Jared Bernstein*, the focus is on his mental meandering, but his meandering was in response to a question from the interviewer channeling Stephanie Kelton’s rhetorical inquiry: “It obviously begs the question, why are we borrowing a money that we print ourselves. I am waiting for somebody to stand up and say, “Why do we borrow our own currency in the first place?”
I might add, why even tax dollars one can print, but I digress, stand up Jared, the answer is ‘inflation’
Here’s the thing, Pierre, you’re right and with respect to me you’re preaching to the choir, but at least one problem with this country is you’ll never win the argument.
“If you listen to people in Washington and talk, they will tell you that inflation is produced by greedy businessmen or it’s produced by grasping unions or it’s produced by spendthrift consumers, or maybe, it’s those terrible Arab Sheikhs who are producing it. Now, of course, businessmen are greedy. Who of us isn’t? Trade unions are grasping. Who of us isn’t? And there’s no doubt that the consumer is a spendthrift. At least every man knows that about his wife.” — Milton Friedman discussing paleoinflation to the dinosaurs back in the 1900s
Its Groundhog Day — again…..and again….Its the same arguments regurgitated. Whether its proponents of Team Transitory or Robert Reich opining about greedflation.
* We’re probably judging Bernstein at his worst moment. He is almost assuredly smarter than that.
Pierre Lemieux
May 15 2024 at 12:02pm
Craig: It’s not better in other countries.
Ahmed Fares
May 15 2024 at 4:24pm
[Selected quotes]
The Man Who Can’t Be Taxed – Steve Landsburg
Ahmed Fares
May 15 2024 at 4:53pm
*facepalm*
Biden’s billionaire tax: White House economist Jared Bernstein defends plan to raise taxes on wealthiest Americans
Pierre Lemieux
May 15 2024 at 8:24pm
Interesting, Ahmed. Thanks for posting.
Richard W Fulmer
May 15 2024 at 12:13pm
The items in the CPI’s “basket of goods” are occasionally changed, for example, hamburger or chicken replaces steak. We are told that such adjustments reflect changes in consumer preference. But at least some of those preference changes are likely the result of the substitution effect. As the price of steak rises, many people buy chicken instead – not because they necessarily like chicken better, but because they can better afford it.
Such changes turn the index into a moving “yardstick,” making it an unreliable gauge of the dollar’s purchasing power over time, though it may be fine for estimating the changing cost of living. Is there a better tool for tracking the dollar’s purchasing power – perhaps one that uses an unchanging basket of goods and services?
Pierre Lemieux
May 15 2024 at 2:33pm
Richard: The problem you raise is an old, much-discussed, and important problem. However, it is not because the substitution effect should not be taken into account, but on the contrary because it is not completely taken into account by the CPI (with the partial exception of the Chained CPI, which is only available since 1999). Very briefly, an individual maximizes his utility (improves his situation) by changing his purchases in response to changes in relative prices (his preferences are assumed constant). When the relative price of mobile phones in terms of landlines decreases (and vice-versa, of course), the rational consumer will consume more of the first and less of the second. If we assume that he still consumes landlines as much as he did before (or, like the ordinary CPI, we wait years to change the weights), we exaggerate inflation and underestimate the change in his real income (calculated by deflating with an index like the CPI). (Note that this is not related to the quality issue, which is estimated in other ways.) To dramatize the problem, imagine if the weights of the CPI had NEVER been changed since refrigerators, washing machines, dryers, vacuum cleaners, dishwashers, etc., came into use, and the old weight for domestic personnel (domestic services”) had also been kept unchanged, the CPI would point to a large decrease in the standard of living over the past hundred years.
The Fed’s Personal Consumption Expenditure price index is a chained index and, for this reason, is much more reliable to estimate how much to deduct from nominal income to obtain “real” income. (I put “real” in scare quotes because a different methodological problem there is no need to enter into here–and also because the CPI is just an indicator of inflation as I argue in my article.)
In The Myth of American Inequality, Phil Gramm, Robert Ekelund, and John Early explain this quite well on pp. 87 ff. To quote from them, here is an example of how the CPI underestimates the substitution effect and overestimates inflation:
Except that it illustrates the importance of relative prices, this issue is however not relevant to my article in Ryan Bourne’s book.
Pierre Lemieux
May 15 2024 at 3:37pm
Richard: I just stumbled on a column by Don Boudreaux on the substitution effect in a narrow and larger sense: https://www.aier.org/article/substitution-effects-and-steering-wheel-daggers/?fbclid=IwZXh0bgNhZW0CMTEAAR38rFvhNFrhpTkRbJRw9QFzZ26LYLR2QMeaAYglquI6UbJSHpYwtb3cyz0_aem_AQDX3wBLvs1WIpPpnmZJwYZRtDQOgzuIuxyWW5z_gvmJ9CsrRo73OCpn_ec5HVPpo25UPsgwjFAk8VARlh42zlk5
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