A recent New York Times story asked if higher inflation is needed. Some favor allowing inflation to increase to 6%, kick-starting our stalled economy. Since the Federal Reserve (Fed) is likely to change interest rates in the near future, consumers should understand the consequences.
The traditional Consumer Price Index (CPI) measures price changes in a static basket of goods and services at the retail checkout lane. The Bureau of Labor Statistics (BLS) selects items and adjusts values to achieve an “apples to apples” comparison despite quality changes in the items over time. Some items increase in price faster than others, e.g. health care prices inflate faster than kitchen appliances. When BLS alters the composition of items in the basket to better track consumer choices, it produces a “chained CPI.”
Producer Price Index (PPI) measures goods and services price changes at stages before retail. The PPI captures fluctuations in the prices of land, energy, minerals, equipment, intermediate goods, bank loans, and labor used by producers.
So who benefits from inflation? A consumer can benefit from inflation if his after-tax income inflates faster than retail prices do. That’s common when skill shortages boost wage rates. Interest rates contain both risk and time-value-of-money components. Since the time-value part of interest is tied to inflation, consumers who have money to lend or to invest can benefit disproportionately when inflation is high. But if inflation rises after a bond is purchased, the consumers can see the market value of the bond decline.
When inflation is too low (as is today’s 1.2%), it leaves employers an inadequate margin to increase profits, tempting them to boost profits by reducing headcount as Caterpillar recently did. Those consumers lose. When inflation is very low, stock buy-backs seem more appropriate than making risky investments that would create jobs. Many seniors who used to depend on 5% or higher CD yields have lived in reduced circumstances since inflation dropped. The consumers who benefit most from very low inflation are those on fixed incomes that will not be altered, e.g. Social Security or a defined benefit pension.
Many agree that today’s 1.2% is below the right level for most consumers. The Fed is expected to halt “quantitative easing” (QE) by Oct 2014. Interest rates and inflation are expected to drift upwards as bond prices decrease, and inflation is forecast to hover at 3% for 2014 and 2015, a jump of 1.8%. Some consumers will win and some will lose.
Alan Daley is a retired businessman who lives in Florida and who writes for The American Consumer Institute Center for Citizen Research