Why isn’t inflation running hog-wild?

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My friend Bill sent out the following e-mail:

During the 1970s we suffered a dramatic rise in inflation.  Whip Inflation Now was President Ford’s response and Nixon had  earlier ordered a freeze on price increases.  I remember complaining to a local store that increased the price of Simlac, a baby milk formula.  The result was they pulled Similac from their store and so I had to get the formula somewhere else where I didn’t know what the price was last week.   At the time I remembered being told that this inflation was a result of Johnson not choosing between guns and butter.  In other words we spent on defense and on discretionary items during the Vietnam War and that led to the inflation of the 70s.  Doing both caused inflation.  But the same conditions seemed to exist  from 2001-2008 with little inflation.  Now, I am hearing that inflation can be expected because there is too much money being created by the Fed.  Too much money in the system.  Yet, I thought classic inflation was caused by too much money chasing too few goods or because of the classic guns vs. butter cause.  Are we really facing a time when we have too few goods available for us?  The price increases in food and energy are not due to too little food or energy but multiple causes: speculation, droughts, increased industrialization in China and other former 3rd world countries.
I struggled through Econ 101 and 102 and now I find a good indicator of why I struggled.  Could someone smarter than me explain the seeming contradictions I have noted above?

I don’t claim to be smarter than Bill, nor am I a professional economist, but I do have a rough idea of what economists think about this subject.  Economists define inflation as an increase of the amount of money relative to the increase in the amount of goods.  The definition is my 1958 Webster’s is “an increase in the volume of money and credit relative to available goods resulting in a substantial and continuing rise in the general price level.” My newer dictionary’s definition is “an increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices.”

According to this, the hangover from the Vietnam war and the 1970s oil price shocks wouldn’t have caused inflation if the Federal Reserve System hadn’t increased the supply of money to accommodate the extra costs.  If the money supply hadn’t expanded, then the Vietnam war spending and the oil price increases would have had to be offset by a fall in the price of something else or by the elimination of some product or service – which probably would have caused a recession.

The amount of money in circulation is determined by the Federal Reserve Board.  The Fed creates money out of thin air and puts it into circulation by buying government bonds; it contracts the money supply by selling bonds and making the money that’s paid for them disappear. Currency and coins are a small and important part of the money supply.

By the end of the 1970s, inflation was so out of hand that the Federal Reserve Board decided to clamp down on the money supply, even though its members knew a recession would result.  Throughout the tenures of Federal Reserve chairs Paul Volcker (1979-1987) and Alan Greenspan (1987-2006), the Fed gave priority to controlling inflation over promoting economic growth and creating jobs.

Economic conditions made this easier than it might otherwise have been.  The weakening of organized labor eliminated the wage-price spiral of the 1950s and 1960s.   Competition from overseas producers kept manufacturing wages and prices down, as did the shift from a goods-producing to services-producing economy.  An unfavorable balance of trade normally would result in a depreciation of a nation’s currency and higher prices, but the U.S. has been shielded from this by the fact that the dollar is (so far) the world’s reserve currency. Stagnation in wages and job growth lessened both the push of costs and the pull of demand.

But since the current recession began, the Federal Reserve Board under the leadership of chairman Ben Bernanke has been increasing the money supply in an effort to pump up the economy.  The question is why this has neither increased inflation nor stimulated the economy.  I think the reason is that for the money supply to affect the economy, it is not only necessary for the Fed to issue new money, but for the money to circulate.  This doesn’t seem to be happening.  Instead the newly-created money is being squirreled away by the big banks or used to pay down their  debt.

There’s another possible explanation, which is that inflation is actually more than the rise in the Consumer Price Index indicates.  The method of calculating the CPI has been changed a number of times since 1982, all in the direction of making inflation seem less than before.  Certainly the cost of food, gasoline and other necessities is up much more than 1.9 percent over last year.

Click on Why There’s Little Inflation, In One Easy Graphic for background information by Ken Houghton on the Angry Bear web log about why the Fed’s easing of the money supply has had so little effect.

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Click on Numbers racket: Why the economy is worse than we know for an article by political analyst Kevin Phillips in the May 2008 issue of Harpers magazine about how the government over the years has tampered with calculations of basic economic statistics.

Phillips cited John Williams, a California-based economic analyst and statistician, who provides alternate economic statistics based on his own calculations of what the index figures would be if the government hadn’t tampered with them.  Click on Shadow Government Statistics for Williams’ home page.

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Most professional economists reject Williams’ figures.  Click on Econbrowser: Shadowstats debunked for a defense of the Bureau of Labor Statistics and a rebuttal of Williams.

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2 Responses to “Why isn’t inflation running hog-wild?”

  1. Tforre Says:

    I don’t care how your so-called economists define inflation because even most idiots can tell you inflation is an increase in the costs of goods and it’s as simple as that. For example corn prices are up 100% from a year ago. That is because we are using most of it for fuel instead of the gas produced from oil that we can’t get enough of because Obama will not allow us to drill for and use our vast supplies under our own soil. When he goes out of office this country and the world for that matter will be better off. No inflation? You have to be kidding!


  2. philebersole Says:

    You and Shadowstats may be right about the CPI, but I doubt there are vast supplies of oil under our own soil. Discoveries of new oil in the United States peaked around 1930 and oil production peaked around 1970.

    Click on U.S. oil production for a chart.

    Click on peak oil for details.

    I don’t think we as a nation should be in a hurry to use up what oil we’ve got left. It won’t go away, and we will be glad to have it in the future.


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