THE the wall street journalThe Commission’s report on reducing the increase in the consumer price index is confusing. At least that is what an economist who understands the difference between changes in relative prices and a change in the general price level, all prices combined, would think. (See “Lower inflation paves way for 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 East inflation. Excerpt from the article cited above:
Housing inflation, which measures the cost of rents and accounts for about a third of the CPI, has kept overall prices high.
If housing inflation exists, we are faced with a conundrum. What happened to the other “product X inflations” in the other two-thirds of goods and services, including, for example, chewing gum inflation? Did this part also keep overall prices high? Or did the rest of the CPI show “product deflation” (the opposite of inflation, as seen in economic depressions)? Is the economy the scene of a permanent struggle between two evils, the inflation of some prices and the deflation of others? Or could it be that some prices have gone up or down? relatively Are house prices different from prices in other countries? But then a contrarian economist would ask—as economists began to ask a few centuries ago—what makes all prices rise together, apart from changes in relative prices? What then does it mean to talk about housing inflation or gasoline deflation?
A simple way to think about relative prices is this. Suppose that only one price changes in the economy, all other prices remaining constant. (This would of course imply no inflation.) The price that changed changed relative to all other prices (although by a different proportion of different prices). Arithmetically, if one relative price changes, all other prices also change relative to it. All prices are relative prices to other prices. Relative prices change all the time, whether there is inflation, deflation, or neither. The two phenomena must of course be distinguished, inflation or deflation on the one hand, and specific changes in relative prices on the other.
Ryan Bourne’s Latest Book The price war (Cato Institute, 2024) contains many discussions of prices in addition to your humble blogger’s chapter, “Inflation does not result from a rise in the price of a product”). Throughout the history of economic analysis, many theories and evidence have supported 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 beyond 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 Andwhen there is inflation (or deflation), a change in the general price level. The graph below is 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 WSJ The economist is not alone in his error. Most journalists simply repeat the rumors they hear, including those of many economists. Perhaps some economists try so hard to simplify what they know for journalists and pundits that the latter end up thinking in simplified economic terms: “inflation is the sum of all price increases,” they seem to think (when inflation, when it exists, is only part of a price change). Other economists seem happy to forget the economic way of thinking when they leave academia and become accountants with large databases and sophisticated statistical software. Still others have mainly political arguments to make, which usually boil down to saying that the government has the situation under control and is taking good care of its “citizens.”
It is as if, in today’s economic jargon, the words for conceiving of relative prices were erased. One can then only think of real estate inflation, food inflation and chewing gum inflation, which, taken together, produce (total) inflation.
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Martian intrigued by Earthlings’ theories on chewing gum inflation
