Tuesday, April 6, 2010

Two Kinds Of Inflation

There are two kinds of inflation: the kind most Americans experience and the kind elites care about. Both are important, but it’s just as important to distinguish between what most Americans worry about when they worry about the prices of goods and what policymakers worry about when they worry about inflation.

I remember back to ECON1 in which I was told that the only way inflation could happen was through expansions of the money supply (i.e. Milton Friedman’s theory), which is more-or-less the elite theory on the matter: make sure you don’t print too many dollars. And you shouldn’t print too many dollars, and those kinds of inflationary expectations are very bad to inculcate.

Meanwhile, though, quite aside from that, we have two quite separate, yet interesting phenomena. We’re in a period of disinflation, edging towards deflation—too-high inflation rates in the CPI has last been a problem in what, the nineties, perhaps? Look at this graph in the middle of this article: that’s a strong downward trend. Price gains don’t appear to be a big problem at all, despite what you’d hear from those who bleat about inflation worries. Nevertheless, if you look at things from a middle-class American perspective, you’ve seen your wages stagnate. Why have they stagnated? A number of reasons, but health care is a big reason: your compensation has risen, but your take-home pay has fallen. And while the cost and quality of your high-def TV has fallen, you also have to deal with sending your kid to college, which will set you and your kid back the price of a decent house.

Your kid, once he or she graduates from college, will have a pretty big debt burden. Speaking as someone who’s just graduated—and who’s lucky enough to have no debt—I can think of a number of people who’d rather be doing something other than the current jobs, but need to take that job to work on that debt. It’s a similar phenomenon, I think, as health care lock: maybe you’d become an artist or entrepreneur or something with a long-term payoff plan, but the debt means that you have to get paid off now. Now, why so much debt? Well, the cost of college has quite obviously skyrocketed. So you might just go to that Wall Street firm or something else like that.

So it seems to me pretty obvious that the raising of prices in these two areas for middle-class Americans is one of the major economic stories of the past two decades, and yet the official economic statistics indicate that inflation is a minor nuisance. How can you reconcile these two things?

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