Upset about inflation? Speak to the central banks

September 3, 2008

3 September 2008

Upset about inflation? Speak to the central banks

This article is excerpted from the 3 September 2008 edition of “globeandmail.com”.

In one hypothetical scenario, Peter Hall, vice-president and chief economist at Export Development Canada, calculates that the inflation rate could fall to 1.0 per cent in Canada, the United States and Europe by next June.... The Canadian rate, he says, could fall below 1 per cent. What condition would be needed to produce these remarkably low rates? Only that food and energy prices decline marginally from the peaks they hit earlier this year. And much of this reversal has (for the moment, at least) already happened. “[It] means one less thing,” Mr. Hall concluded in his weekly economic commentary, “that we all have to worry about.”

Mr. Hall makes the point that the statistical impact of aberrational price increases vanishes 12 months after price peaks – and falls just as dramatically as prices return to normal. Driven by food and energy prices, Canada's increase in its consumer price index (CPI) doubled in three months this year, jumping from 1.7 per cent in April to 3.4 per cent in July. Assuming that these prices have peaked, the CPI could fall quickly toward zero per cent by next summer on a
year-over-year basis.

Food and energy account for 26 per cent of consumer spending in Canada and the U.S., 22 per cent in Britain and 30 per cent in Europe – and increases in these two categories accounted for 80 per cent of all increases in consumer prices in the past year. This means that inflation's “disappearing act” would happen very quickly. Mr. Hall says Canada's CPI could dip to 0.9 per cent by July. In the U.S., the same factors would cut the inflation rate in half by July; and earlier
in Europe (by April).

“The bottom line?” Mr. Hall asks. “Inflation remains a key concern but its sources are concentrated. If commodity price declines persist, headline price growth could fall rapidly.”

But wait. Mr. Hall's musings are instructive – but perplexing, too. In what way can price increases for particular things be considered inflationary in the first place? Isn't “inflation” a phenomenon of sustained, economy-wide price increases? Isn't “inflation” a debasement of the currency? In what way do random price increases signal this debasement? Aren't singular price increases simply specific indicators of supply and demand?

Take oil. Let's say that, whatever the cause – peak oil, speculators or dysfunctional governments – the price of crude oil doubles in a short period of time. In this case, consumers must necessarily spend more at the pump and the energy component of the CPI rises. They must necessarily, however, spend less on other things and the “other things” component of the CPI falls. Category changes aside, these consumers spend the same amount of money.

The “average” cost of living doesn't change. Prices simply do the job they are supposed to do – alerting consumers to shortages and advising conservation.

Most people now, though, use “inflation” to refer to all price increases. Even economists....

But commodity price increases can be inflationary only when they have somehow forced up prices across an entire economy....

Contrary to popular definition... inflation is not really about a general rise in prices but rather about increases in money supply – which are largely invisible. When people say that they have been hurt by price increases, they really mean that they have been hurt by increases in the money supply. When they say that businesses have ripped them off, they really mean that the Federal Reserve (or the relevant central bank) has ripped them off.

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Topic(s): 
Canadian Economy & Politics
Information Source: 
Canadian News Channel
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