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The more important inflation numbers

This piece was first published in The Hill on 4/19/2023


The most important numbers that the Bureau of Labor Statistic (BLS) put out on April 12 are not the ones that get the most attention … the average price changes for All Items (+5.0 percent) and All Items less food and energy (+5.6 percent).

More revealing are the numbers for specific items in the CPI and other government and private reports. These show which goods and services are rising more than the average and therefore are causing average inflation to go up. They are the numbers that should direct policy makers, investors and the public.


Focusing on the average inflation numbers makes the public think that the inflation is the result of “too much money chasing too few goods.” If this were the case, the Fed would be right to slow the whole economy rather than focusing on problem areas, but it is not the case.

Focusing on higher-than-average price changes for items in the CPI like rents, electricity, transportation, and leisure services, on the other hand, would be far less likely to cause a dangerous and unnecessary recession. Above and below average changes signal to buyers, sellers, investors, and government where to invest to increase supply and where to go easy.

Higher inflation in rents (+8.2 percent vs. the 5.0 percent average) signals the need for action in the housing area. Higher electricity prices (+10.2 percent vs. 5.0) and costs for transportation services (+13.9 vs. 5.0 percent) are also problem areas. Slowing the whole economy does not get at these specific problems.

Treating inflation as a question of averages as the Fed has been doing and as analysts have come to see it, risks even more serious mistakes in the future. What if world oil prices jump from today’s $86 a barrel to 10 times that because of some disaster in the unstable Middle East. That is what happened from 1972 to 1981. Such a price shock would drive up average U.S. inflation by much more than the Fed’s 2 percent inflation target.

The question is would another round of inflation driven by oil and energy signal that the Fed should raise interest rates and slow the whole economy or should such a shock lead to even more and faster private and public investment in wind, solar, geothermal, nuclear and the like?

Similarly, what would be the U.S. reaction if drought or war drives up wheat, soybean, and other farm prices all over the world? Should the U.S. reaction be to slow the whole economy to reduce demand for bread and animal feed, or should businesses and the government take steps to increase food production?


Finance poses a similar question. The Fed’s nine interest rate increases and its predictable lack of interest in bank supervision precipitated the Silicon Valley Bank (SVB) crisis. So far, that crisis seems to chiefly be affecting medium sized U.S. banks, but worse probably is coming.

Medium-sized banks like SVB suddenly have to pay much higher interest rates on deposits and short-term securities that are the basis for their long-term lending to smaller businesses that create jobs.

Businesses that traditionally borrow from these banks will find it harder to get loans as well. Rolling over loans at rates that are 4 or 5 percent higher will surely cause some of these borrowers to fail.


Worse, the damage from sharply higher U.S. interest rates is already becoming a worldwide problem. Many financial institutions in developing countries are being forced to match the Fed and pay more for the dollars they need to finance imports and lending to their domestic clients. Rising interest costs likely will force many of these clients to default when they have to rollover loans. Some overseas banks are likely to fail with them.

History suggests the danger here. When the Fed raised rates in 1928 and 1929 to curb stock market speculation in the U.S. the domestic and worldwide damage was slow to become apparent. American stock speculators until the Crash in October 1929 were willing to pay the higher rates. Overseas banks and borrowers were encumbered by war debts and reparations payments, but nevertheless held on for a while.

U.S. speculators in 1928 and 1929, however, gradually sucked lendable U.S. capital out of Europe and into U.S. stocks. This reduced U.S. private lending to Europe that the continent, shattered by World War I, had depended on since the early 20s. It reduced, for example U.S. purchases of German railroad bonds that paid less than loans to the speculators. Over time, this caused banks in Europe to fail as their borrowers defaulted in the face of higher rates.


The unfolding sequence of events that grew out of the Fed’s effort to curb speculation in the late 1920s turned into terrible deflation and the Great Depression. The Federal Reserve failed to manage this and was pushed aside by various New Deal agencies that supported reconstituted banks, businesses and depositors. These government agencies took over most of the Fed’s functions until 1951.

A similar sequence could be beginning to unfold in 2023 because the Fed’s rush to raise rates has forced developing countries all over the world to raise their rates for local loans.

The bottom line is this. The Fed’s focus on average inflation (5.0 or 5.5 percent) and a 2 percent target rate is very risky. Relative price and wage changes are useful signals to buyers, investors, employers, employees and governments. Average inflation numbers are not. The average numbers are a distraction.


Raising interest rates across the board to slow all sectors of the U.S. economy means slower and more painful adjustments to changes that war in Ukraine, more intense rivalry with China, and technological changes require. There are numbers that show where the problems are. They are the ones that Americans should learn to understand.

Paul A. London, Ph.D., was a senior policy adviser and deputy undersecretary of Commerce for Economics and Statistics in the 1990s, a deputy assistant administrator at the Federal Energy Administration and Energy Department, and a visiting fellow at the American Enterprise Institute. A legislative assistant to Sen. Walter Mondale (D-Minn.) in the 1970s, he was a foreign service officer in Paris and Vietnam and is the author of two books, including “The Competition Solution: The Bipartisan Secret Behind American Prosperity” (2005).

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