Tuesday, April 15, 2008

USA Steady Prices Since 1981!

Beloit College where I used to teach annually puts out a mindset list of things people entering college that year have not experienced. If they didn’t do it a few years ago may I suggest students entering college now have never experienced an inflation rate of more than 5.5%. The last time inflation for the year was above 10% the year was 1981 and this economist couldn’t even say the word inflation. This Washington Post article highlights some kids learning about inflation as food prices go up. A friend from Grinnell, Courtney Sherwood, asks some good questions to consider in the face of inflation on her blog:

“Is there any value in saving money, when its purchase power declines with each passing day? What should I spend on now, with the knowledge that it will cost more tomorrow? What is the best way to plan for my future when I don't know what the future holds? I've never been through this before.”

So here is a simple inflation primer.
What is inflation? It is a measure of the increase in prices between years

How does the government measure inflation? Basically they have a set of typical goods called a basket and they see how much the price of that basket changes.
Sometimes reports talk about inflation without food or energy prices in the basket (core inflation), why not include food and gas in inflation? These prices are volatile to weather and political shocks, so they might not reflect well the overall changes in prices.

Why is inflation bad? Some inflation is not necessarily bad, the problem is when it gets too high people realizes prices will soon be going up again so they should buy things sooner, causing more short term inflation. If it gets too out of hand people will have to continually run to the store as soon as pay day hits, causing long lines and a real problems.

So what to do? As Simpsons news anchor Kent Brockman might ask "Professor, without knowing precisely what the danger is, would you say it's time for our viewers to crack each other's heads open and feast on the goo inside?"

No I don’t think it is time to panic. I have heard a few grumblings of worries about inflation from economists, but there seems to be little worry about prices increases in the US, although there may be greater problems internationally. To hedge yourself against inflation you can always buy stuff sooner, but if you want to be part of the solution and not part of the problem consider investing in Ibonds. These are bonds offered by the US government that pay a fixed interest rate plus inflation. If inflation goes up you get a greater return. I own some Ibonds, they probably didn’t do as well as some of my other short term cash investments, but they are now beating my money market account.

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1 comment:

Gregorus said...

According to what I've read, the CPI basket of goods is notoriously off in a lot of interesting ways, so I don't know if I-bonds are really the right response.

They might be if your spending habits generally correspond to what's in the basket, but if what you tend to buy is inflating a lot faster than the things in the basket, it seems like a bad choice (though with high inflation, there isn't much of a good choice, is there?). I think this is the case for a lot of people.

I think the key is to try to structure your life in such a way that the things you are buying are inflating less than the things in the basket. Does that make any sense?