Panic and Inflation

Ayush Kumar • Staff Editor

A graph of the monthly percent change in CPI
Graph courtesy of Ayush Kumar

During the course of the past few weeks one could find numerous articles highlighting the rise in prices, drawing parallels with stagnation during the Carter Presidency. Among the concerned, those concerned for the right reasons have given up on the panic. So what happened? In order to discuss such panic we need to investigate what inflation is and how it is measured.

What is inflation?

Inflation is usually defined as the general rise in the price level of an economy over a period of time. In general inflation is not bad, it is expected, as the economy grows the wages rise which in turn allows business to charge more. However, excessive rise in inflation without suitable rise in economic growth can be an issue. One may wonder how we measure inflation objectively?

How is it measured?

We measure inflation using the Consumer Price Index(CPI), which is the index used to measure the monthly changes in a weighted collection of goods known as commodity bundles. What should be included in this commodity bundle is a matter of debate in the academic world particularly because inclusion of energy and food products, and other goods which are susceptible to regular shocks which may have nothing to do with the general rise in price may make our measure of inflation less reliable.

What does CPI have to do with anything?

The volatility of CPI is one of the key factors in economist’s preference of Core Inflation as measure for rise in inflation. Core Inflation excludes the pressure of transitory changes and thus, is more stable than Inflation measured by CPI. The stability of this index is one of the reasons why The Federal Reserve dismissed the concerns as transitory inflation caused by the Coronavirus pandemic. This explanation by the Fed is why we see inflation numbers decline as the Economy gets out of the transition phase (Figure 1).

One should note here that the spike in reported inflation may result from a variety of transition shocks and need not be limited to say Energy. In particular the recent spikes pertained to supply chain shocks because of the pandemic, however we note that they were still indeed transitional.

Wait, why are there “spikes”?

The magnitude of the spikes can be attributed to the large stimulus packages passed under Trump, and Biden Presidencies. Due to the size of the packages it is completely plausible that there might be a sustained rise in inflation, however, in all probability for this to happen the Fed would have to sit doing nothing. One must note that the Fed has set interest rates at a historic low and further has a plethora of tools to deal with runaway inflation hence, at present inflation does not appear a cause to be concerned.

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