The Wall Street Journal’s report on the reduced increase of the Consumer Price Index is confused. Or so would think an economist who understands the difference between changes in relative prices and a change in the general price level, of all prices together. (See “Milder Inflation Opens Door Wider to September Rate Cut,” July 11, 2024.)
Reading the story, the proverbial Martian landing on Earth would think that, on this strange planet, all prices are the product of inflation (or deflation), that there is no difference between inflation (or deflation) and changes in relative prices, and that the increase in the CPI is inflation. Quoting from the story cited above:
Housing inflation, which measures the cost of renting and accounts for about one-third of the CPI, has kept overall prices high.
If there is such a thing as “housing inflation,” we have a puzzle. What happened to other “product X inflation” in the other two-thirds of goods and services—including, say, bubble gum inflation? Did that part also keep overall prices high? Or did the rest of the CPI show “product deflation” (the opposite of inflation, as we see during economic depressions)? Does the economy witness a continuous struggle between two evils, inflation in some prices and deflation in others? Or could it be that some prices increased or decreased relatively to each other whatever happens to inflation (or deflation)? But then, a contrarian economist would ask—as economists started asking a couple of centuries ago—what causes all prices to rise together besides changes in relative prices? What does it mean then to speak of housing inflation or gasoline deflation?
One easy way to think about relative prices is as follows. Assume that only one price changes in the economy, all other prices remaining constant. (This would of course implies the absence of inflation.) The price that changed has changed relative to all other prices (although in a different proportion of different prices). Arithmetically, if one relative price changes, all other prices also change relatively to that one. All prices are relative prices compared to other prices. Relative prices change all the time, whether there is inflation, deflation, or none of either. The two phenomena obviously need to be distinguished, inflation or deflation on one side, and specific relative price changes on the other.
Ryan Bourne’s recent book The War on Prices (Cato Institute, 2024) contains many discussions of prices besides your humble blogger’s chapter, “A Rising Product Price Doesn’t Cause Inflation”). Over the history of economic analysis, there is much theory and much evidence supporting the hypothesis that inflation—an increase in all prices together, as opposed to relative changes among them—is due to an increase in the money supply over and above what economic agents demand for their transactions. The price of any good or service as observed and included in the CPI is composed of a change in its relative price and, when there is inflation (or deflation), a change in the general level of prices. Reproduced below is a chart published in one of Ryan’s contributions to the book. The correlation between changes in the money supply and estimated inflation supports the hypothesis that inflation is a monetary phenomenon.
We should not be too hard on journalists and the WSJ is not alone in error. Most journalists are just echoing the noises they are hearing, including from many economists. Perhaps some economists are trying so hard to dumb down what they know for journalists and pundits that the latter end up thinking in dumbed-down economics: “inflation is the sum of all price increases,” they seem to think (while inflation, when present, constitutes only part of a price change). Other economists seem happy to forget the economic way of thinking when they leave graduate school and become accountants with large databases and sophisticated statistical software. Still other economists mainly have political points to make, which generally amount to saying that the government has got things under control and is taking good care of its “citizens.”
It is as if, in today’s economic Newspeak, the words to conceive of relative prices were being obliterated. Then, nothing is thinkable but housing inflation, grocery inflation, and bubble gum inflation, which, all added up, produce (total) inflation.
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A Martian puzzled by Earthlings’ theories of bubble gum inflation
