5 things to know about inflation

5 things to know about inflation

Inflation isn’t so scary if you focus on the precise mechanics by which the value of a dollar changes over time – and how it might affect you.

(NYTIMES) – To understand why inflation is so worrying to so many people, you could look at price charts for lumber or used cars or New York strip steaks. There is no doubt that the prices of many of the things that people buy are rising at an uncomfortably rapid rate.

Ultimately, most money is a mere electronic entry in the ledger of a bank. It is worth only what it will buy, and what it will buy changes all the time. When prices move abruptly – as when an economy that has been partly shut down for more than a year tries to reboot – that inherent uncertainty becomes all too real.

But inflation isn’t so scary if you focus on the precise mechanics by which the value of a dollar changes over time – and how it might affect you.

Let’s look at what aspects of the current price surge look more benign, and which are worrying.

1. Relative prices v overall prices

At any given moment, some things are becoming more expensive and others are getting cheaper. That is how a market economy works; prices are what ensure that supply and demand eventually meet.

Sometimes, this happens quickly. Airlines constantly adjust ticket prices; the prices of fresh vegetables bounce around depending on whether they are plentiful or scarce. Other times, it happens more gradually. A hair salon may not raise prices the first day there is a line of customers out the door, but it will do so if it is consistently overbooked.

Those shifts can be annoying – nobody wants to pay US$1,000 (S$1,300) for a short-haul plane ticket or see the price for a haircut double. But they are a healthy part of an economy working as it should. The core challenge of an economy emerging from a pandemic is that industries are going through major shocks in demand and supply simultaneously. That means more big swings in relative price than usual.

2. One-off prices v long-term trends

Not all price changes have equal meaning for inflation. Much depends on what happens next.

If the price of something rises but then is expected to fall back to normal, it will act as a drag on inflation in the future. This often happens when there is a shortage of something caused by an unusual shock, like weather that ruins a crop. In an opposite example, in 2017 a price war brought down the price of mobile phone service, pulling down inflation. But when the price war was over, the downward pull ended.

But a price that is expected to rise at exceptional rates year after year has greater implications. Consider the multi-decade phenomenon in which healthcare prices rose faster than prices for most other goods, creating a persistent upward push on inflation.

3. Wage inflation v price inflation

Media coverage of inflation typically focuses on indexes that cover consumer prices: numbers that capture what it costs to go to the grocery store, buy a car and get all the other things a person wants and needs.

More properly defined, inflation is about the full set of prices in the economy – including people’s wages. Whether there is wage inflation goes a long way to determining how people feel about the economy. For individuals who benefit from bigger pay cheques, that will take the sting out of higher prices for goods. Some may end up better off financially than they had been in lower-inflation environments.

4. Steady inflation v erratic inflation

Many people take it for granted that high inflation is a bad thing. But in truth, it’s not obvious why a country couldn’t comfortably have prices rise much faster than they have in the US in recent decades. Imagine a world where consumer prices rose 5 per cent every year; workers’ wages rose 5 per cent, plus a little more to account for rising productivity; and interest rates were consistently higher than Americans are used to.

In theory, the only problem would be what economists call “menu” costs, the inconvenience of companies having to revise their price lists frequently.

Bond investors appear confident that whatever inflation takes place in the next year or two is a one-off event, not a new normal in which the value of a dollar is unpredictable.

5. Price inflation v asset inflation

Even when consumer price inflation is low, some financial commentators may point to a worrying surge in asset inflation, meaning rising prices of stocks, bonds and other investments.

Economists generally don’t think of asset price swings as a form of inflation. If stock prices rise, it may change the future returns on your savings, but it doesn’t change what a dollar can buy in terms of the goods and services you need to live.

But semantics aside, it seems apparent that millions of people have been ploughing money into meme stocks and cryptocurrencies that might otherwise have gone to bid up the price of home grilling equipment or other things in short supply.

And while there is plenty to worry about in terms of bubbly signs in financial markets – and what it would mean if they corrected downwards, as cryptocurrencies did recently – that doesn’t mean they are making ordinary consumers worse off. You can’t eat Bitcoin; you can’t clothe yourself in shares of GameStop.

Sometimes asset prices rise while consumer prices stand still, as in much of the 2010s. Sometimes consumer prices soar while financial assets languish, as in much of the 1970s. Other times, they move together.

The implication: High asset prices and rising price inflation aren’t the same thing. Whether with asset prices or other aspects of inflation, being precise and detailed is a way to make the essential ephemerality of money a little more concrete. 

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