Trying to make sense of inflation? So is everyone
For many smart people, how inflation works isn’t any easier to understand than COVID-19.
And when we hear, as we did yesterday, that the person who is supposed to be one of the world’s foremost inflation experts failed to see the current round of price hikes coming even after the pandemic, it can strengthen our ego. But it’s not entirely reassuring that the global economy is in good hands.
With forecasts that the latest US inflation figures, released later this morning, could reach a shocking 7.1% – an unprecedented level in the lives of young people – it would be good to know that ‘There’s nothing to be scared of.
A US financial commentary offered a handy tongue-in-cheek guide on how to panic about inflation, which may not be entirely reassuring, either.
Chased by a bear?
But as with any threat, from chasing a bear to battling a new pandemic variant, understanding a little more about what’s going on doesn’t necessarily solve the problem. It can help you cope, however.
The fact that the world’s most influential central banker, Federal Reserve Chairman Jerome Powell, has not seen the current extraordinary levels of inflation in his crystal ball is important information. The fact was recalled during Tuesday’s Senate hearing confirming his reappointment, where Powell was asked how he could avoid a similar surprise in the future.
“It’s a unique situation,” he replied. “We don’t have 10 pandemics to look back on and say these are the common features when the global economy shuts down to deal with a global pandemic. It was just new.”
If Powell and his highly paid experts didn’t see it coming, neither do you.
It’s also a reminder of why the markets have zigzagged with every little new piece of news, not just about what’s to come next, but exactly what Powell and the Federal Reserve are going to do about it. No one can be sure.
A conversation I had over the last vacation with some bright young people reminded me how many concepts of inflation can be unfamiliar to them, at least in part because they never really had to think about it. of their own life.
Even the word inflation can be confusing. For an older generation who saw it happen in the 1970s and 1980s, inflation most likely has obvious intuitive significance.
House prices not included
Many Canadians have an idea of what happens after seeing house prices go up. As an asset and not a consumer good, however, they are not directly included in the inflation figure.
The act of inflating, like inflating a balloon, can give the wrong impression.
Inflation is in some ways akin to blowing the air out of a balloon: the savings in your bank account lose value. In other words, a measure of inflation is that if you, as a Canadian, put a hundred dollars in an envelope last January and took it out to spend now, that would only buy $ 95 of that. that you could have bought. one year ago.
In other words, we’re not talking about money blowing up like a balloon – the prices are. During inflation, the average price of most goods rises, some a little more and others a little less, as the value of money falls.
Methods of measuring inflation can also be confusing.
The number people will be talking about on Wednesday will be the US Consumer Price Index, or CPI. It measures how much it cost last December to buy a certain set of consumer goods and services and compares that to what it cost to buy the same goods and services last month.
Sometimes it’s called “headline” inflation, or the headline CPI, because that’s the number you’ll hear on the news, maybe because it’s more dramatic, but it’s also the real impact of rising prices on household costs during that particular month.
But central banks, including the Bank of Canada, are more concerned with an entirely different number called “core” inflation, which is essentially a measure of inflation that excludes prices that are all over the map, such as inflation. that the prices of food in winter and gasoline prices almost at any time.
Don’t be enough
It can also be confusing that despite a highly integrated North American economy, inflation has always seemed much lower in Canada than in the United States. But just when Canadians may have started to feel smug, Canadian banking economists point out that much of the difference is a discrepancy in how the two numbers are calculated, including the fact that Statistics Canada omitted the rise in used car prices.
Another important concept for understanding inflation is “real” versus “nominal”.
At Tuesday’s confirmation hearing, following Powell’s upbeat comments on the wage increase, US Senator Pat Toomey asked a question as to why a dollar value, or a “nominal” increase in income can only be seen in light of the “real” increase after subtracting inflation.
“There have been comments about the wage gains,” Toomey said. “But the wage gains that are further wiped out by price increases do not leave a family any better off.”
In my holiday conversation about inflation, one of the young people I was talking to scoffed at the idea that their bosses never offer a five percent pay raise because in their experience wages don’t only increased by one or two percent. This is called inflation expectations.
Powell knows he’s in a race with these tame expectations, and they’re not going to last if high inflation persists.
Asked about keeping inflation under control with higher interest rates, Powell has repeatedly pointed out that while rate hikes can control borrowing and therefore demand for goods, the current main drivers of inflation are global supply problems, something that rising interest rates will not solve.
“I expect we will see some relief on the supply side over the course of the year,” said Powell. “If that doesn’t happen and we see inflation become even more persistent… then I think the risk of it taking root in the psychology of businesses, households and people, I think it increases.”
And if supply chains don’t repair themselves quickly, rising inflation expectations and entrenched inflation could become the biggest threat.
Follow Don on Twitter @don_pittis