Introduction Definitions and Basics
● Inflation, from the Concise Encyclopedia of Economics
● Economists use the term “inflation” to denote an ongoing rise in the general level of prices quoted in units of money. The magnitude of inflation–the inflation rate–is usually reported as the annualized percentage growth of some broad index of money prices. With U.S. dollar prices rising, a one-dollar bill buys less each year. Inflation thus means an ongoing fall in the overall purchasing power of the monetary unit….
● In the United States, the inflation rate is most commonly measured by the percentage rise in the Consumer Price Index, which is reported monthly by the Bureau of Labor Statistics (BLS). A CPI of 120 in the current period means that it now takes $120 to purchase a representative basket of goods that $100 once purchased….
● Inflation, at SocialStudiesforKids.com.
● One of the concepts of economics most talked about by adults is inflation. Simply put, inflation is a rise in prices relative to money available. In other words, you can get less for your money than you used to be able to get….
● Consumer Price Indexes, from the Concise Encyclopedia of Economics
● The purpose of a price index is to summarize information on the prices of multiple goods and services over time. Consumer spending accounts for about two thirds of the U.S. gross domestic product (GDP). The Consumer Price Index (CPI) and the Personal Consumption Expenditure deflator (PCE) are designed to summarize information on the prices of goods purchased by consumers over time. In a hypothetical primitive society with only one good–say, one type of food–we would not need a price index; we would just follow the price of the one good. When there are many goods and services, however, we need a method for averaging the price changes or aggregating the information on the many different prices. The rate of change of prices–inflation–is important in both macro- and microeconomics….
● Consumer Price Index 101, by Tawni Ferrarini at CommonSenseEconomics.com.
● The Consumer Price Index (CPI) is a measure of the costs of purchasing the representative bundle of goods and services consumed by urban households during a period relative to a base period. It is used to perform three important functions: (i) determine whether general prices are higher, lower or stable over time, (ii) calculate the annual rate of inflation, and (iii) convert nominal values to real. (This conversion allows us to adjust prices, wages and incomes for differences in the general level of prices across time periods.)…
● Hyperinflation, from the Concise Encyclopedia of Economics
● Inflation is a sustained increase in the aggregate price level. Hyperinflation is very high inflation. Although the threshold is arbitrary, economists generally reserve the term hyperinflation to describe episodes where the monthly inflation rate is greater than 50 percent. At a monthly rate of 50 percent, an item that cost $1 on January 1 would cost $130 on January 1 of the following year….
● Deflation and disinflation: Money Supply, from the Concise Encyclopedia of Economics
● … Economic activity declines and either disinflation (reduced inflation) or deflation (falling prices) results….
In the News and Examples
● Allan Meltzer on Inflation, podcast at EconTalk. Feb. 2009.
● Allan Meltzer, of Carnegie Mellon University, talks with EconTalk host Russ Roberts about the current state of monetary policy and the potential for inflation. Meltzer explains why inflation hasn’t happened yet, despite massive increases in reserves created by Fed policy. Then he explains why inflation is coming and why it will be politically difficult for the Fed to stop it. Meltzer also analyzes the Japanese experience in recent years and talks about why so many investment banks overreached and destroyed themselves.
● Adjusting for inflation is important: Capital Gains Taxes, from the Concise Encyclopedia of Economics
● The tax treatment of capital gains has other unique features. One is that capital gains are not indexed for inflation: the seller pays tax not only on the real gain in purchasing power, but also on the illusory gain attributable to inflation. The inflation penalty is one reason that, historically, capital gains have been taxed at lower rates than ordinary income. In fact, Alan Blinder, a former member of the Federal Reserve Board, noted in 1980 that, up until that time, “most capital gains were not gains of real purchasing power at all, but simply represented the maintenance of principal in an inflationary world.”…
● How does the Federal Reserve control inflation? John Taylor on Monetary Policy, podcast at EconTalk
● John Taylor of Stanford University talks about the Taylor Rule, his description of what the Fed ought to do and what it sometimes actually does, to keep inflation in check and the economy on a steady path. He argues that when the Fed has deviated from the Rule in recent years, the economy has performed poorly. Taylor also assesses the chances for a monetary or financial disaster and the Fed’s recent expanded role in intervening in financial markets.
A Little History: Primary Sources and References
● Gold Standard, from the Concise Encyclopedia of Economics
● Widespread dissatisfaction with high inflation in the late seventies and early eighties brought renewed interest in the gold standard. Although that interest is not strong today, it strengthens every time inflation moves much above 6 percent. This makes sense. Whatever other problems there were with the gold standard, persistent inflation was not one of them. Between 1880 and 1914, the period when the United States was on the “classical gold standard,” inflation averaged only 0.1 percent per year….
● Irving Fisher, from the Concise Encyclopedia of Economics
● Fisher was a pioneer in the construction and use of price indexes. James Tobin of Yale has called Fisher “the greatest expert of all time on index numbers.” Indeed, from 1923 to 1936, his own Index Number Institute computed price indexes from all over the world.
● Fisher was also the first economist to distinguish clearly between real and nominal interest rates. He pointed out that the real interest rate is equal to the nominal interest rate (the one we observe) minus the expected inflation rate. If the nominal interest rate is 12 percent, for example, but people expect inflation of 7 percent, then the real interest rate is only 5 percent. Again, this is still the basic understanding of modern economists….
● The Theory of Interest, Part 4, Ch. 19, “The Relation of Interest to Money and Prices, by Irving Fisher.
● No problem in economics has been more hotly debated than that of the various relations of price levels to interest rates. These problems are of such vital importance that I have gone to much trouble and expense to have such data as could be found compiled, compared, and analyzed. The principal result of these comparisons are given in this chapter….