High inflation versus high prices

While the consumer price index (CPI) may get the most headlines, the measure of inflation that’s reportedly of greater significance for Federal Reserve policy makers is the core inflation rate, which measures inflation for all items excluding food and energy. In February and March, this metric clocked in at 6.4%, year-over-year — the highest figure since 1982. At this level, an inflationary psychology is becoming an increasing concern, as households and businesses incorporate expectations of elevated inflation in their contractual arrangements. If unchecked, these expectations can become self-fulfilling prophesies.

I share this concern and for that reason support the Fed’s planned program to reduce the pace of monetary expansion and raise interest rates. Although this shift in the Fed’s emphasis will likely dampen the pace of economic activity, we can afford that sacrifice because we’re starting from a place where the economy has been growing at a healthy rate and the unemployment rate has reached its lowest level (3.6%) since the start of the pandemic.

As this new policy orientation takes hold, we should be clear about what it will likely accomplish and what it won’t. Specifically, I expect ongoing vigilance by the Fed to keep inflationary expectations under control. On the other hand, we should realize that the Fed has no capacity to roll back prices in markets where chronic shortages are present. Put another way, high inflation is a distinct problem from that of high prices; and while we can look to the Fed to help counteract the former, we can’t expect it to do much, if anything, about the latter.

By definition, a shortage exists when something that is desired isn’t available in sufficient amounts. Economists characterize this state as one in which demand exceeds supply. In a free market, price adjustments serve to alleviate this problem. That is, the price of the scarce good would rise until a balance between quantities supplied and demanded are restored. This market-clearing price is termed the equilibrium price. Obviously, those unable or unwilling to pay the new equilibrium price would be forced to accommodate by either (a) purchasing cheaper, substitute goods, (b) scaling back on their purchases, or (c) doing without altogether. In any case, the price would be functioning as a rationing mechanism; and without reliance on prices to serve this purpose, we’d have to employ some rule-making bureaucracy to allocate the scarce goods.

Some may feel that allowing prices to serve this rationing function is inherently unfair as the end result clearly favors the rich, for whom the higher price wouldn’t be an impediment. True enough; but even with this recognition, having prices functioning to ration scarce goods still beats out the other alternatives. That said, I recognize the need for some accommodations for special cases, as in “necessities.” Defining what qualifies as a necessity, however, is a fraught exercise. We should all agree that potable water is a necessity, but as we extend consideration to food, shelter, and health care — all seemingly necessary for the maintenance of civilized lives — consensus as to what is truly necessary starts to fray.

If concerns about high prices are sufficiently dire, Congress and the administration could take action to mitigate the pain. Gas prices, of course, have captured national attention as the poster child for this problem; and in response to the high prices we’re experiencing, Biden has authorized release of 1 million barrels a day from our strategic oil reserves. In a word, this is a dumb plan. The idea of bringing down a particular price for everyone is overly ambitious. It can’t be done in a way that would be truly meaningful for anyone. A more targeted approach should certainly be preferred. (Regardless, if we are willing to draw down strategic reserves, the better plan would be to direct that oil to our NATO allies to strengthen the resolve of the coalition to isolate Putin.)

As far as how to counter high prices, my idea would be to restrict assistance to those feeling the most pain. This objective could be realized by providing income supplements to poor people — i.e., people who already qualify for government safety net programs like food stamps, unemployment, housing assistance, and/or whatever. Such a design would obviate the need to establish any new qualifying hurdles for participation in the program. All that would be required is additional funding authorizations.

Amounts of these supplements could be adjusted to respond to the excess of the price index for some critical basket of goods (or perhaps just gas by itself in the current situation), verses some threshold level. The higher the index relative to the threshold, the larger the benefit, and vice versa. The new supplemental assistance could function as an automatic stabilizer, bumping the benefits provided under existing satetynet programs as needs grow, with the prospect of sunsetting these supplements when needs subside.

At this stage, it seems to me that the distinction between high prices and high inflation is lost on the part of the public and on the part of our policy makers; and for policy makers who prioritize improving the lives of Americans, the starting point should be identifying high prices as the more potent of these two problems. We’ll never truly “solve” the problem of high prices, but we can surely mitigate the effects for the most vulnerable among us. We just have to summon up the political will to do so.