“Core” Inflation

September 28, 2007

Quotes like this one always surprise me:

The 1.8 percent rise in core inflation over the past year, which excluded energy and food, was within the Fed’s comfort zone for core price increases of between 1 percent and 2 percent, meaning they could cut again.

You might ask why a graduate student in Economics is surprised by such a sentence, so I’ll tell you:

To begin with, most people spend a very, very significant portion of their incomes on food and energy. If the prices of these goods are rising (or falling) the average consumer is sure to suffer (or feel relief) in proportion to the magnitude of the price changes. To pretend that the prices of food and of gasoline or petroleum or coal are somehow exogeneous and independent of money prices, is simply retarded.

To review: prices will not rise unless there is an increase in the demand relative to other goods, or if there is an augmentation of the money supply relative to productivity, all else being equal. In the first instance, it is important to note that the prices for other goods will fall, whereas in the latter, the prices for other goods will remain the same, or even rise. Only the latter is inflation proper.

Inflation is always and everywhere a monetary phenomenon. Measuring inflation as if it is the dependent variable in an equation with consumer goods representing the independent variable is about as wrong-headed a statement as you can possibly make. Although it is true that the price of gasoline doesn’t cause inflation, it is no less true that the price of any other good or service cannot cause inflation, either. The fact of the matter is that all goods should be excluded from the price indices, and what we’d be left with is a simple monetary quantity and vector.

Which is quite simply understood: when money is created out of thin air, inflation is the inevitable side-effect. Of this, there is no uncertainty. There is no such thing as “core” inflation; either money is being created (which causes inflation) or it is not.


Posted in: Economics Lessons

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