Since the late 1970s something like a victory, at least a temporary one, seems to have been won in the ““war,’’ as it then was called, on inflation. Back then, many sober people considered inflation the natural outcome and potential destroyer of democracy. The theory was that electoral dynamics impel politicians to spend in excess of revenues, piling up deficits that cause inflation. And debasement of the currency as a store of value devalues virtues indispensable to a successful society–thrift, industriousness–and drains government of legitimacy.
However, in 1980 the president who presided over three years of double-digit inflation was defeated. In 1981-1982 the Fed’s tight money policies wrung out most inflation by putting the economy through the worst recession since the Depression. Two years later the incumbent president carried 49 states. Two conclusions were drawn from this. One was that inflation, far from being endemic to democracy, makes electorates conservative and furious. The second conclusion was that inflation can be controlled because ““everyone knows,’’ and the Fed especially knows, the conditions that produce inflation–for example, a level of unemployment much below 6 percent.
Trouble is, the latter conclusion may be mistaken. One of the things that ““everybody knew’’ not long ago was that large budget deficits produce inflation. But Reagan’s deficits coincided with declining inflation. Besides, America’s economy, like the world economy with which it is meshed, may be changing in ways inhibiting to inflation. It is too much to say, as protectionists and labor leaders and other alarmists do, that wages around the world are being set in south China. But the entry into the world labor market of billions of Chinese, Indians, Bangladeshis, Indonesians and others does dampen wage-driven inflation pressures. So does immigration, and the weakness of America’s private-sector unions, and workers’ anxieties inflamed by hyperventilating journalism that exaggerates the menace of corporate ““downsizing.’’ It is no accident that, as Peter Passell of The New York Times reports, work stoppages have declined from nearly 400 involving 2.5 million workers in 1970 to 31 involving just 192,000 in 1995.
Critics of the Fed say its fear of inflation is unreasonably inflated because its understanding of the causes of inflation is pedantic and dated. As a result the Fed may inhibit economic growth with unnecessarily high interest rates. In the last quarter the economy sizzled and unemployment fell. But these glad tidings spell trouble because of Will’s Law of Economic Understanding, to wit: All news is economic news and all economic news is bad. Really good economic news, like last quarter’s 4.8 percent growth rate and August’s 5.1 percent unemployment rate with inflation said to be only about 3 percent, is especially alarming because the Fed does not subscribe to Mae West’s axiom that too much of a good thing is wonderful. So the Fed’s critics fear it may tighten money lest an ““overheating’’ economy ignite inflation.
This could put two prominent conservatives at odds. Today’s Fed chairman, Alan Greenspan, became a hero of contemporary conservatism by being a hawk against inflation. But the core of Bob Dole’s campaign is his proposed 15 percent tax cut, and the premise of the proposal is that the economy can safely–that is, without inflation–be stimulated to grow significantly faster than the less than 3 percent rate of recent years. Amid the clash of certitudes that always characterizes economic policy debate, one modest thought deserves more attention than it gets: the real inflation rate is almost certainly less than it is said to be. The Consumer Price Index supposedly measures inflation, and actually contributes to it. It overstates inflation, perhaps by as much as a third. This has enormous consequences for government budgets and the entire economy.
The CPI is commonly, and incorrectly, called a measure of ““the cost of living.’’ It really is only a measure, and a highly imperfect one, of the cost of consuming a fixed ““market basket’’ of goods that is updated approximately once a decade, to accord with changes in consumption patterns. Pat Moynihan notes that the current CPI ““basket,’’ last updated in 1987, still does not include the cellular phone. Furthermore, it is methodologically difficult for the CPI accurately to reflect the ““quality-adjusted prices’’ of commodities that sell for slightly higher prices as they become of substantially higher quality. Between 1950 and 1965 the quality-adjusted prices of refrigerators, washing machines and air conditioners declined, and did so much faster than the CPI indicated. Furthermore, Moynihan notes, the CPI does not reflect price- driven changes in consumption patterns: if beef prices rise rapidly, shoppers may buy more pork or poultry. If energy costs surge, consumers may buy less fuel but more insulation. Moynihan notes that such substitutions are not reflected in the CPI, which ““assumes the purchase of the same market basket, in the same fixed proportion (or weight) month after month.''
A recent commission of scholars concluded that if the CPI overstates inflation by one percentage point per year through 2005, this will add almost $140 billion to the deficit that year and $634 billion to the national debt by then. ““The bias alone would be the fourth largest Federal program, after Social Security, health care and defense.’’ So, you think, at last something everyone can agree on–the need for a more accurate CPI. Think again. Moynihan notes that about half the American people have incomes or benefits indexed to the CPI. This is a huge constituency for inaccuracy.
Politics may prevent the fixing of the CPI. Prudence should prevent the Fed from fixing an economy that isn’t broken. The CPI’s flaws are one more reason for the Fed on Tuesday to do what government rarely has the wisdom to do: nothing.
