South-Western College Publishing - Economics  
Is It Inflation or Isn't It?
Subject Inflation
Topic Employment, Unemployment, and Inflation
Key Words Inflation, Consumer Price Index, Federal Reserve, Monetary Policy, Productivity
News Story

Should we again start worrying about inflation? Increases in the Consumer Price Index (CPI), our primary measure of inflation, have been around 2 percent for the last two years. The financial crises in Asia, Russia and Latin America, coupled with declining raw material prices, have generated much talk about deflation rather than inflation. But the view of the Federal Reserve appears to be that our recent record with inflation is not the result of a restructuring of financial markets; rather it is the product of a few lucky breaks. That view may lead the Fed to raise interest rates at its next meeting.

There is evidence that the inflationary picture is changing. The economies of Asia and Europe are recovering. Energy prices are rising, the dollar is falling and investors appear to be shifting some of their money away from U.S. markets. The high value of the dollar kept import prices low and helped control inflation.

But not all of the inflation news is bad. Inflationary expectations are still low and have not put pressure on wages and prices. Low import prices were not only the result of a strong dollar but also overproduction in many Latin American and Asian economies and this excess production is expected to continue. Skyrocketing medical costs were an important cause of inflation in the early 1990s and show no sign of returning to their previous rates of increase.

There are many economists who believe that the underlying structure of the economy has changed. More flexible labor markets, the decline of monopoly and union power, deregulation, the computer revolution, productivity growth and technological advances have made our labor markets more efficient and the economy less susceptible to inflationary pressures. The economy is still operating with excess capacity and could conceivably continue to grow without inflation.

Milton Friedman has argued that inflation is a monetary phenomenon. What happens to inflation depends importantly on what the Federal Reserve does.

(Updated October 1, 1999)

1. What is the difference between anticipated and unanticipated inflation? Why might consumers prefer steady inflation to a situation where prices are volatile?
2. What does the Consumer Price Index measure? Is the CPI a good indicator of the amount of inflation that you face? Explain.
3. According to the article, Milton Friedman has argued that what happens to inflation depends importantly on what the Federal Reserve does. How can the Federla Reseve influence the rate of inflation? What instruments does it have available to do this?
Source Sylvia Nassar, "Inflation? It Just Doesn't Add Up," The New York Times, August 22, 1999.

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