The Fed Is Still Trying to Understand Inflation

By: Robert Aro

It’s been over a hundred years since Mises wrote The Theory of Money and Credit and since the inception of the Federal Reserve. Yet the Fed is still trying to figure out inflation, so much so that the Reserve Bank of Cleveland operates the Center for Inflation Research (CFIR) in order to:

improve the understanding of policymakers, researchers, and the public about inflation and the factors that influence its behavior.

The research center’s Inflation 101 infographic makes their understanding quite clear:

Have you ever been shopping and noticed that the prices of things you buy have gone up? If the same things in your shopping basket cost $100 last year and now they cost $105, at a very basic level, that’s “inflation.”

To mainstream economists, mainstream media, and the academic community, the word “inflation” means the increase in prices of consumer goods or services, as measured by the Consumer Price Index (CPI) or other inflation calculators. Using this definition, if the government imposes minimum wage laws or tariffs, if OPEC cuts oil production, or if toilet paper shortages occur due to panic, all which lead to price increases, it constitutes “inflation.” But this definition does not add up. When prices increase, it becomes nearly impossible to say if it was due to the Fed or some other factor. How, then, is the Fed supposed to control inflation, when countless factors contribute to it?

Those familiar with Austrian economics acknowledge this usage of “inflation,” and may use it in conversation, but the Austrian also understands the history and significance of using the term “inflation” to denote the increase in supply of money and credit. Contrast this to the Fed’s research center, which does not even acknowledge inflation’s history or the effects of using its original definition.

Perhaps, since their definition is unclear, they rephrase it:

Explained another way, inflation is ongoing increases in the general price level for goods and services in an economy over time.

This further convolutes understanding, as it introduces the notion of a “price level.” Central planner estimates, we are told:

Statistical agencies start by collecting the prices of a very large number of goods and services. In the case of households, they create a “basket” of goods and services that reflects the items consumed by households. The basket does not contain every good or service…

Once the basket of goods is decided they determine:

the current value of the basket by calculating how much the basket would cost at today’s prices (multiplying each item’s quantity by its price today and summing up). Next, they determine the value of the basket by calculating how much the basket would cost in a base period (multiplying each item’s quantity by its base period price). 

They fail to mention that the items and quantities in the basket can change from period to period, but they go on to explain “relative weights”:

In the case of a price index for consumers, statistical agencies derive the relative weights from consumers’ expenditure patterns using information from consumer surveys and business surveys.

Thus, the Fed understands inflation only when statisticians create a basket of goods and assign a relative weight of importance to each item. Between each period of comparison, the items, their quantities, and the relative weight of importance may be adjusted. Once complete, the Fed has their “data,” used to justify their policies. Nowhere does anyone seem to ask what the harm to society would be if their data is incorrect, or worse, inherently flawed.

Austrian economists have been vocal about the latter, saying there is an inherent problem of “measuring inflation,” for many generations, yet a research center which claims to be dedicated to inflation research somehow remains unaware. And even as recently as last year, Frank Shostak wrote a concise essay on the price level, concluding that:

Contrary to popular thinking, there is no such thing as price level that should be stabilized by the central bank in order to promote economic prosperity. Conceptually, the price level cannot be ascertained notwithstanding the most sophisticated mathematics.

Whether it’s the price level, defining inflation, or expansion of the money supply and its side effects, the Austrian school has written against these interventions for over a century. It would benefit society if an economic research center run by the Fed would consider these ideas; unfortunately, it seems they either don’t know or don’t care.

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