We’re now being told that inflation is good, which is the fourth and final phase. This gets us to the most interesting part of the story. Supply chain shortages or more money chasing the same goods? I find the supply chain narrative unconvincing. We have had month after month of record trade deficits, importing vastly more than we are exporting. That narrative would hold some validity if we were importing less than we were in the past, if a worker shortage and other COVID effects were cutting into our capacity to process imported goods and get them distributed to markets across the country. Fix those supply chain problems, and it will all go back to normal, or so the story went. We were all shown pictures of ships backed up at the ports, waiting to offload goods into a system where we just didn’t have the workers or the capacity to unload it. One thing to note on the transitory argument is that it largely hinged on so-called supply chain shortages. This year, it is up 10.6% over last year, including some items that are up more than 20%, such as almond bark (27%), coconut flakes (23%), and molasses (20%). The Christmas Cookie Inflation Index conveniently avoids substitution effects (don’t you dare substitute these ingredients) and also hedonic adjustments, since it is the same base ingredients year after year. I think that is too comforting for policymakers and don’t subscribe to that interpretation. Many economists and politicians call this an increase in accuracy. The goal, and it’s not really a secret, is to adjust inflation rates downward from what would be reported if the same basket of goods were reflected over time. It’s a lot like computing time lost to congestion when trying to justify a road widening, but ignoring it when building an interchange. The way you know that substitution and hedonic adjustments are a gimmick is that they only work in one direction. For you, the price goes up while you are told “there is no inflation.” That works in theory-especially for the affluent, where this price differential is not critical-but the reality is that you don’t have the option of buying the cheaper television with fewer features. You are paying more, but you are getting more. Your new television may cost 500% more than the television you bought a few years ago, but if it is determined that the television is 507% more valuable because of all the new features, then an hedonic adjustment will say that the price has actually gone down by 7% ( that’s the example given on the BLS website). Hedonic adjustment is another method used to reach the same conclusion. This is why many of us have long experienced rising prices while we’re told “there is no inflation.” If you can no longer afford steak because the price has gone up and instead switch to eating chicken, that actually reduces the rate of inflation, since your overall cost of living is now less. As the Bureau of Labor Statistics (BLS) suggests, “the dominant substitution effect is one of consumers shifting toward relatively cheaper products.” In the mind of an economist, this has the effect of overstating inflation, so substitution adjusts the inflation rate downward to compensate. For example, if steak is too expensive, you can substitute chicken. Substitution is the idea that people react to changing prices by substituting one set of goods for another. In other words, this basket is comparable over time without needing substitution or hedonic adjustments, two mechanisms used to suppress inflation during the first two phases of the inflation story. These are the same ingredients my grandmothers used for decades baking the same cookies. Let’s start with the Christmas Cookie Inflation Index, a basket of 10 ingredients I use to bake cookies. Money given to non-elites as part of COVID recovery chased the same goods-notably, labor-and, predictably, prices went up, dramatically in many instances. This year saw inflation escape into the common narrative. Unfortunately, too simple doesn’t mean wrong. The inflationary mechanism of more dollars chasing the same number of goods is too simple (and inconvenient) to be worthy of intellectual objectification.
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