One of the more vigorous species in market punditry today is the inflationista: those who believe that inflation, as opposed to slow growth, is somehow the primary problem the economy is facing.
Given the fact that yearly price increases have stayed below the Fed’s 2% goal for the 24 months prior to its most recent reading of 2.1%, it’s confusing that inflationistas are taking pot shots at the Fed.
Here’s the Guardian’s Heidi Moore writing yesterday about rising food prices:
Moore is perturbed by the fact that while prices for the specific items she mentions are rising above the Fed’s target, Fed Chair Janet Yellen and company seem to be only concerned with other measures of inflation–particularly what is known as “core” inflation, a measure that strips out food and energy prices. Larry Doyle, investment advisor and author, echoed this sentiment this morning on Twitter:
While it’s admirable that these analysts are arguing that Fed should concern itself with the welfare of the average American, these criticisms show a lack of understanding of economics and a tendency to overestimate any central bank’s ability to improve the living standards of the median citizen.
So, what’s wrong with the analysis? A few things:
1. You can’t just look at the prices of a few items and declare that inflation is a problem. Yes, food and housing are staple items that we all need to buy, and when those prices rise, it’s not great for Americans. But economists have spent decades trying to improve measures of inflation that take into account all prices. Americans, for instance, spend more money on transportation than they do on any other item besides housing, and prices for used cars and trucks increased by 0.2% in the past 12 months, far below the median increase in pay of 2.1%.
You can cherry pick just about any number to make a point, but there’s a reason why we have specialists at the Labor Department, who study inflation for a living, working on this problem. It’s so we can have a good overall measure of inflation.
2. There’s also a good reason why economists at the Fed strip out food and energy prices when judging their performance with respect to inflation. Energy and food prices fluctuate greatly due to factors like wars and weather. Would that Janet Yellen could wave a magic wand and stop droughts in California or wars in the Middle East that can lead to big jumps in prices of those items, but she can’t.
What Yellen can do is control the size of the money supply to keep prices stable. But how does the Fed decide whether prices are rising due to the amount of money in the system or due to factors outside its control? One way is to strip out those volatile prices and look at others, like those for apparel or automobiles, that are historically more stable and less susceptible to supply shocks. If those prices are rising too quickly, there’s reason to believe that there’s a money supply problem, rather than a weather or war problem.
3. Since core inflation isn’t rising, it’s not likely that the inflation in food prices we’re seeing is a problem the Fed can address. What it can address, however, is the disappointing amount of GDP and employment growth in the economy right now. The Fed is trying to foment more of that growth by keeping interest rates low. If, instead, the Fed raised interest rates, as the inflationistas seem to want, in order to combat higher food prices, economic and employment growth would almost certainly slow down.
By all means, we should keep the Fed’s feet to the fire. It’s too important of an institution for pundits to give a free pass, but proper analysis of its performance requires a solid understanding of what central banks can — and cannot — do.