Even the NYT sees it

Byline: | Category: Economy | Posted at: Wednesday, 30 March 2011

When even the New York Times acknowledges that inflation has arrived, you know that it’s really arrived.

The story is about how some food manufacturers are disguising the effects of inflation by reducing package sizes rather than increasing prices.  It’s worth reading, but probably not a surprise if you do the grocery shopping in your family.

There are two additional points I’d like to make.  The first is about this excerpt:

Thomas J. Alexander, a finance professor at Northwood University, said that businesses had little choice these days when faced with increases in the costs of their raw goods. “Companies only have pricing power when wages are also increasing, and we’re not seeing that right now because of the high unemployment,” he said.

What Mr. Alexander is espousing here is akin to the Phillips Curve, which postulated that there was an inverse relationship between unemployment and inflation.  That theory crashed on the rocks of reality in the 70s and early 80s when stagflation proved that higher inflation and higher unemployment could coexist quite comfortably. 

Actually, if Mr. Alexander had seen the article’s previous paragraph before he made his comments, he might have chosen his words differently: 

Where companies cannot change sizes — as in clothing or appliances — they have warned that prices will be going up, as the costs of cotton, energy, grain and other raw materials are rising.

Bottom line:  Higher producer prices create one of two choices for manufacturers:  smaller containers, or higher consumer prices. 

I’m actually seeing quite a resurgence of Phillipian economics, some of it from none other than Fed Chairman Ben Bernanke, who has purposefully pursued inflationary policies in the hopes that a little bit of inflation would create jobs.

Sorry.  It doesn’t work that way.  And that’s because Bernanke–and millions of others–fundamentally misunderstand what inflation is.  That’s my second point from the article.

The Consumer Price Index–i.e., rising prices–is not inflation.  The CPI is a measure of the effects of inflation, just as a thermometer is a measure of the effect of temperature on mercury.  A higher temperature means mercury expands within a sealed tube, but just as with the thermometer, the CPI lags inflation.  Heat–what the thermometer attempts to define–is simply energy.  When there’s more of it in a discrete space, what we can measure–the mercury–rises.  Inflation–what the CPI attempts to define–is simply the value of money.  When there’s more money in a discrete economic space, the CPI rises. 

Of course, the CPI lags an increase in the money supply much more than the expansion of mercury lags an increase in the heat energy of the environment.  The lag is months or years instead of seconds.  And that feeds the illusion that central bankers have the magic ability to check inflation before its effects are disastrous.  I have no confidence in the ability of any man to be a better steward than an invisible hand.

Finally, there actually is a third option for manufacturers confronted with higher producer prices.  They don’t have to raise prices or reduce quantities.  Instead, they can choose to reduce costs.  Of course, a principal means of doing so is by reducing payrolls or off-shoring operations.  And that is why inflation and unemployment are eager cohabitors.

See this for more.  Also, Karl Smith and Megan McArdle discuss their surprise at the apparent resurgence of the Phillips curve here (begins about 1:15).

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2 Responses to “Even the NYT sees it”

  1. Michael Says:

    This is the discredited quantity theory of money.

    Your analogy to a thermometer, like all economic analogies to eighteenth century physics, is highly misleading.

    Inflation is an abstract theoretical concept. It is not a property of any natural phenomena, other than the minds of economists.

    When prices respond to changes in the supply of, or demand for, money, we say “inflation is occurring,” and we are not at all surprised to find that different prices respond differently. We might average several such changes in prices, in order to create a price index, another abstraction. Contrary to your assertion, specific price indices are actually more “real” phenomena than the theoretical price-level, which is a cognitive shorthand for uniform, across the board price changes that do not ever actually occur in real life.

    Food inflation is thus a misnomer. While food prices, along with other prices, could conceivably respond to an increase in the supply of money, or a decrease in the demand for money, a much more likely explanation is that the real costs of food production are rising, due to a combination of factors (energy price increases caused by the global oil production peak, increases in the average trophic level of the global diet, and so-called modernization of commodities futures trading).

    I hardly think that flogging a pre-scientific concept of money qualifies you to better understand inflation than the Fed Chairman. Perhaps he is the Fed Chairman because he actually understands what modern money is and how it works. Meanwhile here you are, claiming that the sky is falling, and inflation is occurring, even in the face of massive unemployment and unused capacity.

    Ed: Two to five years from now, when the effects of inflation are in full boil, I want you to go into a grocery store and walk up to a mother with a fist full of coupons and a face full of worry and tell her to stop being concerned about “abstract theoretical concepts.”

  2. Bill Alexander Says:

    The big advantage of smaller sizes is the big banner “Lower Calorie formulation!”