Daniel Gross adds his voice to the chorus of people complaining that "core inflation"--inflation excluding food and energy prices--is a silly measure. They're mad because this silly measure is the one the Fed pays most attention to.
And the Fed is right. The reason the Fed watches inflation is to try to determine if the money supply is in excess of money demand. If it is, there will be too much money chasing too few goods, and prices will start to rise.
But those price increases will be broad, general price increases, led by demand. The problem is, food and energy prices are generally most affected not by fluctuations in demand, but by fluctuations in supply--or in the expectation of future supplies.
Gross compares American inflation to China, where food inflation is rampant. But in China, most people still don't have enough to eat by rich-world standards. That means that when they get a little extra money, they will often bid up the prices of food commodities, particularly expensive ones such as pork. Until supply increases to match increased demand, this will result in skyrocketing, demand side prices.
In America, however, food is a trivial part of almost everyone's budget. People who get a little extra money in their pocket don't spend it on putting more protein in their diet: they buy a nicer washer, an iPod, a nice trip to the Jersey Shore. Price fluctuations are driven by the size of the harvests here and abroad. Similarly, the change in the price of oil has not been caused by a sharp shift in American demand, but by increasing demand elsewhere running up against a limited supply.
In other words, though it may hit your wallet hard, these two kinds of inflation don't tell us much about the state of the money supply--whether it is too big, too small, or just right. They just tell us that the domestic market for these goods has experienced some kind of negative supply shock. And that's not in the Federal Reserve's power to correct.
"In order for an economy to experience a general rise in prices, there must be an increase in the money stock."
http://www.mises.org/article.aspx?Id=908&month=42&title=Defining+Inflation&id=44
Mises explained in his essay "Inflation: An Unworkable Fiscal Policy":
"Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. . . . As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation."
Posted by Mark E Hoffer | October 1, 2007 11:27 AM