Hey, Mr. President, all your congressmen too. You got me frustrated, and I dont know what to do. I’m trying to make a living, I cant save a cent. It takes all of my money, Just to eat and pay my rent. I got the blues, got those inflation blues. So sang the great BB King back in 1986.
But that was then and this is now, and our government tells us that inflation simply does not exist anymore. In fact, the Federal Reserve would like to see more inflation since it is somehow good for the economy when prices rise. According to the Consumer Price Index (CPI-U) which is really a cost of living index rather than a measure of price increase, inflation has been running at an average rate of just 2.4 percent since the beginning of this century. This seems quite low for someone like me who grew up in the 1970s when inflation ravaged the country, but it still means that prices will double every 30 years or so. Even so, 2.4 percent inflation seems reasonable – or does it.
Inflation is a measure of the purchasing power a person’s physical money. If I have a dollar today, it will only be worth 98 cents in a year. But if I know that I will have $1.02 in a year, if inflation is running at 2 percent then everything is a wash. Inflation can get to be inconvenient particularly when it is running at a very high rate (the classic picture of Germans toting wheelbarrows of money around to buy a loaf of bread is in every economics textbook), but in effect, if my income is rising in line with inflation then I am at least treading water, and if it rises faster than inflation then I am doing great.
The problem with inflation occurs when prices rise at a faster rate than income, which has been the experience in America over the last dozen years. While there have been ups and downs in both income and inflation, overall, income has been growing at a slower rate than the cost of living (about 30 percent since 2000). In fact, if income had grown at the same rate as inflation (so that the average person was at least treading water), then the average per capita income today would be about 3 percent ($740) higher than it is. And that is to just tread water. And this represents total income. If we just look at wage income then just to keep pace with inflation since 2000, average wages and benefits should be about $912 higher than they are now.
On top of this, it is likely that the CPI underestimates actual inflation since it takes into account shifts in purchasing patterns, many of which are due to inflation. For example, if people find that the cost of fish is rising, they may switch their purchases to poultry, or if they find it is getting expensive to purchase a home they switch to renting. All of these changes lead to a statistical lowering of the inflation statistic, but are all actual increases in prices felt by consumers. The BLS itself admits that the way it calculates the CPI probably underestimates inflation by 0.3 percentages points per year. This small change suggests that inflation has been 38 percent since the turn of the century rather than the 33 percent reported in the CPI.
So even though reported inflation looks low, it is actually high relative to wages and income which is what really matters. Lower purchasing power due both to inflation and slow wage growth is what leads to the inflation blues.