[quote]No, I am talking about a rise in the costs that matter most to people. If the price of everything you need rises by 10%, and the price of everything you could buy but don’t need drops by 10%, that’s not a wash.[/quote]
[quote]But in Queens, New York, on Friday, William Dudley was bombarded with questions about food inflation, and his attempt to put rising commodity prices into a broader economic context only made things worse.
“When was the last time, sir, that you went grocery shopping?” one audience member asked.
Dudley tried to explain how the Fed sees things: Yes, food prices may be rising, but at the same time, other prices are declining. The Fed looks at core inflation, which strips out volatile food and energy costs, to get a better sense of where inflation may actually be heading.[/quote]
There’s a huge confusion here.
Like I always said, there are different kinds of inflation, and different ways to compute them, and you always need to ask, WHY you are thinking about inflation, before you can pick the right measure.
The Fed is concerned with inflation that is caused by printing money. It is very different from inflation that is caused by rising demand for commodities from China or by limitations of oil output capability in the Middle East.
The Fed can combat the former by monetary tightening. There’s nothing that the Fed can do about the latter. If anything, monetary tightening would make things worse, because it would bring down incomes.
[quote]If the price of everything you need rises by 10%, and the price of everything you could buy but don’t need drops by 10%, that’s not a wash. [/quote]
Look at it this way. You have X dollars to spend every month. You used to spend 0.1*X dollars on wheat and oil, and the remaining 0.9*X dollars on everything else, from healthcare to car insurance.
If wheat and oil genuinely become more scarce in the world, you’ll have to spend 0.2*X on wheat and oil, and 0.8*X on everything else. Prices of “everything else” have to come down, because a lot of “everything else” is domestic services, and the aggregate output of such services in the economy is constant. You will clearly see that the price of wheat has gone up 100%, but you may not notice that a lot of other stuff has gone slightly down. Even though wheat and oil are only a small part of your budget.
CPI less food & energy goes _down_ after such a shift. This is completely by design. In fact, the Fed might want to print some money in this situation, to keep the nominal cost of “everything else”, and, therefore, CPI, constant. (Because producers of “everything else” are paid sticky wages, and wage deflation is best avoided.)
If the Fed prints too much money, you’ll have 2X dollars per month, you’ll spend 0.2*X on oil and wheat and 1.8*X on everything else, and CPI will correctly record 100% inflation.
