LegiStorm

Summary:

Since the end of World War II, the United States has experienced almost continuous inflation—the general rise in the price of goods and services. It would be difficult to find a similar period in American history before that war. Indeed, prior to World War II, the United States often experienced long periods of deflation. Note that the Consumer Price Index (CPI) in 1941 was virtually at the same level as in 1807. For more than two decades, the inflation rate has remained low, in contrast to the 1970s and early 1980s. This is true regardless of which of the many available official price indices is used to calculate the rate at which the price of goods and services rose. A low inflation rate is especially significant since the U.S. economy was fully employed, if not over fully employed, according to many estimates for the last three years of the 1991-2001 expansion and during 2006-2007. Yet, contrary to expectations, the inflation rate accelerated only modestly. Keeping an economy moving along a full-employment path without sparking higher inflation is a difficult policy task. During the last two recessions (2001 and 2007 to 2009), policymakers have been more concerned about the threat of deflation (falling prices) than inflation, and they have pursued unconventional policies to prevent it. Prices fell in 2009, but have risen at a low and stable rate since. Given the relationship between inflation and the money supply, some economists are concerned that the rapid growth in the portion of the money supply controlled by the Fed since 2008 could cause rapid inflation. To date, those concerns have not been realized, primarily because of the large slack in the economy. Because labor costs make up nearly two-thirds of total production costs, the rate at which they rise is often regarded as an indication of future inflation at the retail level. They tended to rise in the latter stage of the 1991-2001 expansion and to moderate during the subsequent contraction, recovery, and expansion that ended in December 2007. Rather than measure inflation by using the rate at which prices overall are rising, some economists prefer a measure that reflects primarily the systematic factors that raise prices. This yields the "underlying" or "core" rate of inflation. The overall inflation rate exceeded the core rate in eight years during the 2000s. Although economic theory does not prescribe an optimal rate of inflation, many economists would support the goal of price stability, which former chairman of the Federal Reserve Alan Greenspan once defined as existing when inflation is not considered in household and business decisions. Why should the United States be concerned about inflation? This study reports the distilled knowledge of economists on the real cost to an economy from inflation. These are remarkably more varied than the outlays for "shoe leather," long reported to be the major cost of inflation ("shoe leather" being a shorthand term for the resources that have to be expended on less efficient methods of exchanges). The costs of inflation are related to its rate, the uncertainty it engenders, whether it is anticipated, and the degree to which contracts and the tax system are indexed. A major cost is related to the inefficient utilization of resources because economic agents mistake changes in nominal variables for changes in real variables and act accordingly (the so-called signal problem). Inflation in the United States during the post-World War II era may not have been high enough for this cost to be significant.