So why isn't there inflation in the US?

The US dollar has lost value dramatically in the past year compared to most non-Asian currencies. Normally this would cause inflation, since imported goods have become relatively more expensive. And you'd think the classic definition of inflation as too much money chasing too few goods would begin to have an effect. The money supply in the US has been growing rapidly for some time now due to extremely low interest rates. But despite these conditions, US inflation rates as reported by the governent have remained quite low.

Bill Fleckenstein, one of my favourite financial mavericks, looks at this question and lays the blame on shifty government statisticians. One of the ways they do it is through the black art of hedonics:

For those of you who don't know, hedonics is the way the government transforms price declines into quality improvements. To wit, you buy a PC with twice as much power, so the government concludes that you really paid only half as much money for it. Hedonics is also the government's way of taking quality improvements and converting them into price declines when calculating the CPI. Sure, that brand-new Chevy you just bought cost 40% more than it used to, but it's a 40%-better car for a variety of reasons. So, the government says, the price didn't really go up. (I have oversimplified these examples, but you get the point.)

The idea behind the first case at least makes some sense, though the government carries it too far by acting as though improvements can be precisely measured. The problem with the second case is that those quality improvements are not voluntary. Since you have to pay the new price, it's sheer silliness to say that the price really didn't go up.

Another way inflation is kept down is through what's called a chain-weighted price index. This depends on the assumption that consumers will change their buying habits when prices increase, and thus will not be greatly affected by it. Richard Benson gives an example:

If you like steak, but the cost of beef goes up so you end up buying less expensive chicken, prices for you didn’t really go up that much. However, if you really like steak, your standard of living has just gone down, because you can no longer afford it.

When an organization has a vested interest in making misleading statements they should be carefully scrutinized. It is very important for the government that inflation stays low. Most government obligations such as pensions and salaries are tied to the inflation rate. Higher inflation would increase interest rates and make it more expensive for them (and consumers) to borrow. Budget makers would have to take out the axe.

Defining away the problem doesn't really get rid of the problem, it just hides it. Commodity prices are increasing rapidly when measured in US dollars. The carpet these problems have been swept under is starting to look pretty lumpy.

Posted by Bruce Gottfred at February 24, 2004 08:50 AM | TrackBack