The Truth About Inflation

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The Truth About Inflation

Recently, some pundits have been pointing to rising prices and proclaiming that the U.S. economy faces the threat of inflation (or even hyperinflation). Their argument boils down to this: The prices of food, gas, and college tuition have skyrocketed, leaving consumers with less purchasing power. That, they conclude, means trouble ahead for the economy.

To understand the situation, let's take a closer look at the numbers and their meaning.

It's true that the prices of some items have gone up recently. We'll examine those specific items later. What really matters, however, is the overall level of inflation, across all categories. The most widely used measure of inflation—the Consumer Price Index (CPI), which includes food and energy—has only gone up by an annual average of just 1.6 percent since 2008, including 1.5 percent in 2013.1

Taking a longer view, inflation in general, and food inflation specifically, has not been a serious problem in the United States over the past 15 years.

However, inflation has risen slightly during the past year. For the 12 months ending June 30, 2014, the "headline" CPI has gone up by 2.1 percent. The "core" CPI, which does not include food or energy prices, rose at a lower rate of 1.9 percent.2

At the same time, the Personal Consumption Expenditure Price Index (PCE) was up 0.2 percent in May. That broad measure was consistent with "core" consumption prices, which exclude food and energy. Notably, PCE prices are up 1.8 percent in the past year.

To validate these government-generated metrics, it is helpful to consider MIT's Billion Price Project. It examines, monitors, and summarizes prices on a vast assortment of items charged by hundreds of online retailers throughout the world. By that measure, U.S. inflation rose barely more than 2 percent over the past year.

Even in categories in which prices are rising, we need to consider the impact of rising wages. What a family can afford isn't affected only by the increase in prices; it's also affected by how much money they are earning. As long as wages increase in line with prices, there is no net impact on a consumer's purchasing power.

With that in mind, let's look at average hourly earnings for private workers. Hourly earnings went up 47.2 percent over the past 14 years, from $13.98 in June 2000 to $20.58 in June 2014. As University of Michigan economist Mark J. Perry points out that, when adjusted for overall price inflation of 37.7 percent during that period, there was an increase in real wages of 6...

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