It is almost December 23rd and that means that Festivus is nearly upon us. (Actually, Festivus is floating holiday that can be observed whenever one chooses to.) It is traditional on Festivus to air one's grievances. And this Festivus, I got a lot of problems with you people. My problems with you mainly concern inflation – the cause of it rather than the description of it. Related to this is the incorrect, in my opinion, assumption made by the media and many economists that increased government spending causes higher inflation. In addition I have a problem with the media reporting that the headline number of an economic release was higher/lower than economists expected.
The faster rise in consumer prices began to be noticed in the spring of this year. Rather than discussing the cause, economists and the media tended to describe the faster increases in various consumer price indices. For example, the rate of consumer price inflation was increasing because used car prices were racing ahead. And if were not increases in used car prices one month resulting in an increase in a consumer price index, it might be restaurant meals the next month. This reminds me of President Calvin Coolidge's "analysis" of unemployment, to wit, "[w]hen more and more people are thrown out of work, unemployment results." I suspect Cal wished he had been silent on this one. But this was the initial "analysis" of rising consumer price inflation this past spring. Inflation went up because the price of this or that item in a price index went up. This is merely a description of an increase in price inflation.
Then soon we had new definitions of "core" inflation such as all items excluding the prices of food, energy and used cars. In other words, if we exclude items with rising prices, higher inflation rates vanish. In December 2021 energy prices have fallen, which likely will moderate the rate of increase in consumer price indices. I wonder if a new "core" definition will be trotted out, this one including energy prices but excluding shelter costs.
In my opinion, the concept of "core" inflation has done a lot to discredit economists. Fed Chairman Arthur Burns is responsible for its inception. In 1973, the global economy suffered two negative supply shocks – the failure of anchovies to show up off the coast of Peru, which indirectly caused a sharp increase in animal protein prices, and OPEC's decision to cut oil production. Chairman Burns asserted that the increases in food and energy prices were not caused by his management of monetary policy. He was right about food prices; not so much about energy prices. In August 1971 the Nixon administration discarded the 1944 Bretton Woods international monetary arrangement whereby the US dollar was fixed to gold at a price of $35 an ounce and other foreign currencies were tied to the US dollar at fixed rates. So, an era of floating exchange rates was entered into after August 1971. Leading up to and after the 1971 Nixon "shock", Burns oversaw an explosion in the growth of thin-air credit (the blue bars in Chart 1). The foreign exchange value of the US dollar collapsed after the Nixon "shock", as illustrated in Chart 1 by the decline in the US dollar vs. the German D-mark (the red line). What does this have to do with the price of oil? OPEC was receiving US dollars for its sales of oil, US dollars that were declining in terms of purchasing power. In an attempt to restore the purchasing power for the US dollars it was receiving for its oil sales, OPEC raised the US dollar price of their oil by cutting production. And, oh yes, there was the matter of a war between Israel on one side, Egypt and Syria on the other side in October 1973, after which OPEC imposed an embargo on oil sales to countries viewed as Israeli allies. Whether the Yom Kippur War was the real reason for the OPEC embargo or just convenient cover for the action could be debated, as I am sure it will be in comments to this epistle. Why not? ‘Tis the season to air one's grievances.
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