U.S. inflation rates, causes, and measurement accuracy

U.S. Inflation: Causes, Cost, and Prevention

The concept of introduction, loosely defined is a drop in the value of money, or the goods being purchased for a certain amount of cash now costs more in terms of cash. This causes discomfort to individuals as they feel that they are 'paying more' for the same item. What they often fail to realize is that the emoluments have also gone up, and thus the general discomfort in paying that extra amount of money is notional.

Inflation in any country is created by the policies of the government and related financial institutions.

Inflation in United States

[TABLE HIDDEN]

(Inflation Rate in Percent for Jan 2000-Present)

From the table given above, it is clear that inflation in USA has been between the lowest limit of 1.07% a year in June 2002 and the highest limit of 3.73% a year during this period. In terms of trends there is no clear trend for the entire period, and even during the current year, though there was an increasing trend in the first four months, there has been a decline in May. In 2000, the measured inflation rose to a peak of 3.76%, then dropped and again reached a level of 3.73%. The entire period is full of rises and falls. However, there had been a rise for the period from January 2005 to April 2005. However, it is important to be accurate in observations of the data, and in many instances a calculation to 2 decimal places gives a finer picture than calculation to one decimal place as is in the statements of the government financial institutions. Naturally, this is a finer or more accurate view.

This can be seen in the case of January and February 2005 where the government index showed that both months had an inflation rate of 3%, but when one goes down to two decimal places, it shows that the inflation in January was 2.97% and the inflation in February 2005 was 3.01%. This makes it clear that during that period inflation had a rising trend. A similar example exists during August 2003 and September 2003 where the government index showed the inflation rates were 2.2% and 2.3% during the two months. Looking at that, one would say that the increase in inflation during that period was only of 0.1%, but when one goes down to two decimal figures, it shows that the increase was by 0.16%, and that figure is a lot more different from 0.1%.

Inflation -- Causes

Thus one can say that the main cause of inflation is the presence of excess money in the system. This time for inflation, part of the reason are the efforts of the Federal Reserve and their efforts to hold off a recession due to the effects of the terrorist attacks on 9/11 and the ending of the tech stock rises.

These were the reasons why they brought down the rates for overnight federal funds down immediately to 1%. This was followed up by President Bush with tax cuts in three efforts consecutively. The budgets that were passed by the Congress had very high deficits and the statutory debt limits went way above the figure of $800 billion and reached to the present figures of $7.38 trillion. The massive monetary and fiscal stimulus is very high for the system. To protect the system the efforts of the federal authorities have already started and they have raised the rates for federal funds to 2% so that the economy does not get overheated. At the same time, the Federal Reserve can act the other way should they want and in 1989 they had renewed their commitment to contain inflationary pressures.

At that time, they had raised the cost of money to contain inflation. The direct effects of inflation are clearly seen and the first of these are the fall of the value of the dollar against the other currencies. This has been reflected in the fact that value of dollar has fallen by 5% when compared to the Euro during the last three months. Another effect of inflation is that the employers start hiring and this process of hiring also increases the wages of the employees. This is seen in United States where the current unemployment rate in the country is at 5.4% now but there is increasing employment, and thus the country is getting to a situation of a tighter labor market. This is helping the labor, but at the same time, this is also increasing the supply of money and contributing to an increase of inflation. The final and important situation affecting inflation is the gradual increase in oil prices. This increase in prices is also a cause for inflation, but at the same time, there will be a time when the companies will start passing on these costs to the consumers.

That will negate the influence in increase of inflation.

Costs of inflation

The effects of inflation have been directly seen by the manufacturing industry and this is seen in the steep rise in the price of oil during the current year, and that has risen by a 150% during the current year. The manufacturers are trying to control costs and that includes efforts to keep prices at a low level. This is really difficult in a year when the labor market has become so tight. It has already been seen that Federal Reserve Board has increased the interest rates twice in their efforts to stop the growth in inflation. There have been increases in import prices due to the weaker dollar. This is not only leading to higher prices for items in electronics, cars and toys, and shoes, but is also helping the American companies to increase prices, but not control inflation.

The ill effects of inflation on the economy are well-known and there have been a great emphasis in recent years on the use of achievement of inflation targets as the main indicators for judging the success or failure of central banks and their control of monetary policy. While they are being judged, the new systems have also given these banks a lot of new methods through which they can reach this goal. Since the number of paths have increased, it is also clear that these organizations now have a lot of choice for the paths that they can take.

At the same time, inflation remains a problem for the public at large and has to be taken as a problem by the banks and not as a theoretical exercise. This should be taken separately from other paths of government like the fiscal policy to be adopted. The reasons for the choices made by institutions is often not so clear, and it is also not clear that the organizations responsible for inflation stabilization also have to take care of the fiscal policy and coordinate with the monetary authority for the complete choice and necessary action. It is true that for price stability there is a commitment to a suitable monetary policy and also a suitable fiscal policy. The theories of 'Ricardian equivalence' do not imply that fiscal policies are not relevant, except when the 'Ricardian policies' are concerned. Thus it is important to understand the role of fiscal development when a non-Ricardian regime is in operation and one of the illustrations of this is in the bond-support regime that was going on in the 1940s.

At the same time, it is often said that when disinflation is delayed, then the final cost of the process of disinflation increases. This is the view of experts of monetary policy. There are not many empirical studies that test this view of costs of disinflation. The experience now shows that delaying disinflation increases the output loss for every unit of reduction of inflation, and even this effect is not seen to be of statistical significance in all models. The biggest changes due to this delay take place when the inflation has just started and this can be attributed to the loss in credibility of the central bank which is in charge of the economy under inflation. This view has also been supported by the Board of Governors of the Federal Reserve system in 1994 through their statement "Countering [the] threat of inflation with more restrictive monetary policy could risk small losses of output and employment in the near-term but might make it possible to avoid larger losses later should expectations of higher inflation become embedded in the economy."

Thus what is required is a monetary-fiscal regime with attractive properties and this involves a monetary policy with a target for nominal increases in deficit as also a commitment for the fiscal policy. There are some theories for this view and the main support comes from two suppositions. The first of these is that fiscal policy has little significance in determining inflation and the second point is that monetary policy does not influence the government budget. The first point is considered as it is viewed that monetary policy is not an important consideration for the major industrial nations as the increase in revenues through monetary policy are low when compared to the total government revenue. This calculation neglects another result of monetary policy and that is the effect that monetary policy has on outstanding debt. This effect comes through the price levels of debt on future price level of the debt, and the future price level of the bonds. The effects are also through the reflected cost of interest for that debt, as this is affected by the interest costs that have to be paid.

It is also argued that inflation has no real influence on the demand of products from the consumers, and this should control the effect of inflation on the demand for goods. Yet fiscal shocks affect demand and these are the consequences of monetary policy on demand. The reason for this are the disturbances that are caused to private budgets through the change of prices, and these can be removed from affecting demand only if the government budget takes care of these disturbances which is not a practical solution. This can be affected only through fiscal policy, and thus the central bank has to determine the fiscal policy for the country to maintain a financial equilibrium. In simple textbook terms this can be stated as a process for countries with a strong fiscal position as fiscal exigencies determining the size of the real government budget deficit that must be financed; then this budget deficit is determined to the central bank as a part of the seigniorage revenue that it is created through the creation of money; and the increase in the growth of money will finally determine what the inflation will be and for this logic there are a number of theories.

Through these theories, it is clear that fiscal developments affect the rate of inflation in a country, and this happens only because they affect the monetary policy. This makes it clear that inflation still remains a 'purely monetary' phenomenon. This supports the view that when the government and the central bank are committed to an anti-inflationary policy then there has to be a suitable monetary policy to ensure price stability. At the same time, this is doubtful whether this theory will be applicable to a country as advanced as United States. It is said that these countries have an independent central bank and that does not have to accept the targets that are set by the Treasury.

Inflation also has a lot of good effects. An increase in inflation means an increase in wages and real estate prices. There will also be gains for individuals who have fixed rate loans which result in stable mortgage payments. This is a problem for lenders. They lend money in sums of hundreds of thousands of dollars, and due to inflation, the value of the repayments that are received by the lender decreases as the value of money itself goes down in terms of buying power. All bonds are also long-term loans and that is the reason why the bond markets are also hurt by inflation. Thus, when lenders feel that there is a likelihood of inflation, the lenders in the market start demanding higher rates of interest before inflation starts actually. These demands for higher rates ultimately bring the entire economy to a standstill as no development takes place due to the high cost of money in terms of interest rates.

The situation today

Well one sure method of controlling inflation is what we have already discussed and that is the return to the gold standard, but that is not likely to happen in today's world. Another index also showed a dip along with the drop in inflation index that we have seen in the beginning of this paper. This was the Consumer Price Index or CPI as given by the United States Department of Labor. The drop was by one-tenth of a percentage point in May after an increase by five-tenths of a percentage increase in April. This makes it clear that inflation is directly related to CPI as the patterns for change of inflation were also similar. When the effects of food and fuel were removed through the use of the 'core CPI', the rise of the index was still by less than a tenth of a percentage point. This increase was less than the expectations of the economists. The reasons for the increases were due to surges in prices of only a few items like, toys, TV sets, Air fares and admissions to concerts, sporting events and movies. At the same time, there was moderate inflation for most food items and lower costs for transportation. The lower costs for transportation was due to lower prices of gasoline. The final opinion of experts was "Overall inflation, while not dormant, is under control."

Thus the question of inflation whether it is rising or falling also depends on the views of the expert and his politico-economic affiliations.

Conclusion

The reasons for the start and increase of inflation are rather difficult to determine, and the earlier bout of inflation was tied up to the productivity slowdown. Yet, the productivity slowdown took place in 1970s and not 1960s when the inflation started. The disinflation exercise for that round was taken up only in the 1980s, and the inflation only peaked then and dropped down after that. The federal authorities were quite sluggish about it. At the same time, when analyzing the inflation patterns of many other countries, inflation took place only at about the same time, and the increase and decrease patterns followed the same curves. This only tells us that the same situation can be repeated. From 1995, the economy in United States had received a large growth in capital investment and this was due to computers and information technology. This had led to growths in productivity and declines in inflation. This had led some experts to believe that a shift in the growth rate for the economy had occurred, and in the positive direction.

There has also been the belief that monetary policy could lower unemployment at the cost of higher inflation -- the famous Phillips curve trade off. There have also been arguments in favor of this logic due to the memories of the Great Depression. This led to high inflation and the authorities needed to experience it before they decided to bring inflation down. At the end of it all the policymakers have to clear their minds and decide -- reduce inflation. This had happened in the early 1980s by chance. It is possible that present inflation is also not being controlled by the government authorities as they expect inflation to contain unemployment, which is another problem in the country as is being expressed by a large section of people. Thus one has to look at the total picture before deciding whether the inflation is within tolerable limits or not. The government has also provided individuals the methods to protect their money during the course of inflation.