Prices Are Increasing, But It's Not The Fed's Fault

There's been a rash of articles lately in conservative venues complaining that inflation is higher than people are willing to admit, and that this increase in prices is squeezing the vaunted middle class. Amity Shlaes wrote one of the more widely discussed of these in National Review. There have been many critiques of this line of thinking from the right as well, such as this American Enterprise Institute piece. However, it's a line of argument which is tantalizingly easy for people to wrap their minds around, while the working of prices and inflation is the sort of thing that can easily make your head hurt. So there's also a more down-home sort of article such as this one from The Federalist, which makes the modest assertion that consumer prices have increased faster than wages since the recession, and that this hurts consumers.

“Americans should stop whining about food prices.”

That was the message AEI’s Mark J. Perry blasted last September to families gullible enough to believe that rising food prices were a problem:

It’s a favorite pastime in this country – Americans love to complain about rising food prices. Even when they aren’t. In fact, given all of the complaining you would never know that average food price inflation in recent years is actually the lowest in several generations. Below are three reasons that Americans should stop whining about food prices, and be a little more appreciative of how affordable food is in the US today, especially when compared to other countries, or when compared to previous decades in US history.

Perry’s three reasons for why American families should stop whining were that 1) Americans spend a smaller percentage of their budgets on food than they did 60 years ago, 2) people in other countries spend more of their money on food than we do, and 3) the four-year moving average of food inflation is low.

To which I say: so what? None of those supposedly devastating critiques of the “inflation is real crowd” came even close to addressing the real problem for millions of American families: namely, that the prices of stuff they buy are growing a lot more quickly than the wages they use to buy that stuff. Yes, it’s nice that we spend a smaller percentage of our budgets on food than other nations do or than our grandparents did after World War II, but that’s cold comfort to a working mom trying to figure out how to buy $20 worth of meat with only $15 left in her pockets.

Now, he's right. A number of key consumer goods have increased in price faster than wages in the 2008-2014 time period, food and gas key among them. I pulled a couple of the key categories off the Consumer Price Index website and looked to see how the prices have increased from 2007 to 2014:

Overall CPI: 12%
Food & Beverage: 17%
Apparel: 7%
Medical Care: 21%
Recreation: 3%

During that same period average hourly wages have increased 14%, so food and medical are are both definitely increasing in price faster than people's wages are rising. Some types of food have increased significantly more than the average for the category.

The reason why inflation worries find an audience is that they take a clearly observable phenomenon (prices have increased) and blame it on a little understood one: inflation and the actions of the Federal Reserve.

Yes, the Fed has tried to achieve low levels of inflation. Yes prices have increased significantly on some key consumer products. However, while inflation (in terms of increasing the money supply -- or "printing more money" to use the populist phrase) does tend to result in increased prices, increases in the money supply are certainly not the only thing that increases prices.

Increasing the amount of money in circulation will tend to increase the prices of everything (including wages and interest rates) in a country. Two big reasons you would want to do this to spur the economy are:

1) If our money gets "cheaper" compared to the currency of other countries, the prices of the goods we produce will get "cheaper" for customers in other countries, while the cost of imported goods will rise in our country. This means that with inflation we will tend to export more and have more tourists come to visit us. The inability to inflate their currencies (because they share the Euro with Germany, France, etc.) is one of the things that has hurt poorer countries like Greece and Spain in the European financial crisis. Back before the Euro, they would have inflated their currencies thus spurring imports and tourism and helping to get their economies back on track

2) Constant but low inflation acts like an annual decrease in both wages and prices. This can be a help in resetting prices since people don't like to accept pay cuts. Often a company will lay workers off rather than reducing the wages of their existing workers. With a low level of constant inflation, a company's real wage expenses are always going down (while they make this up with the workers they value most by giving them raises) thus making layoffs less frequent. Getting stuck in a job where your company won't or can't give raises is bad, but it's often better than getting laid off entirely.

However, prices also increase for reasons having nothing to do with the money supply. During the last 20 years, prices of food and energy commodities have generally been on the increase. One of the major reasons for this is that much less of the world is in abject poverty than before. As countries like China develop, the number of people able to drive cars and buy meat at the store has been going up faster than the supply of gas and meat. As a result, these commodities and many others have increased as a simple result of supply and demand. (Other goods which depend on labor efficiency and technology have gone down in price or increased slower than inflation: electronics, clothing, etc.)

Inflation is almost certainly not the main driver of price increases on gas and food -- nor on education and medical care, though there the reasons for increases are driven by a whole other set of factors than those I've just discussed. Even if inflation hawks succeeded in reining in the Fed or re-establishing a gold standard, we could expect to see food and oil costs going generally up over the coming years. Increases in technology and efficiency are allowing the world to produce more of these than before, but the demand is increasing even more rapidly and in a situation in which the demand for something increases faster than its supply, increasing prices is the way that the market encourages people to modify their behavior to consume less of in-demand items. We can expect more of the same until we reach something like a new equilibrium.