A recent newspaper headline, “Inflation delays road projects,” bemoaned the fact that a number of scheduled repairs and construction projects on North Carolina highways might not occur on time, due to rising construction costs. The author called these higher costs ‘inflation,’ however. This is a common mistake, and not just a semantic difference. Inflation is an economy-wide issue; it doesn’t occur in one market or one industry alone.
During an inflation, both costs and prices are usually rising, so it’s easy to misidentify the symptoms of inflation as inflation itself. It’s true that costs of highway construction in North Carolina have risen, as compared to original estimates. This is fairly common with public projects, whether due to unforeseen scarcities or to inaccurate estimates. As costs rise, legislators in North Carolina will have to decide whether to raise taxes, scale back or eliminate projects, or to borrow against future revenues (one of the chosen options).
The statistics on inflation are far more accurate over a longer period of time than over a short one. But we track inflation by calculating changes in the price of a given collection of market goods, so a short run change in the price of one significant item in the basket, such as concrete or asphalt, can affect the basket price in the short run—and lead to a misinterpretation of that change as ‘inflation.’
For producer goods, the index of price changes is a Producer Price Index. The consumer equivalent is the CPI, or Consumer Price Index. In the long run, only changes in the money supply, in productivity, or in both, change the level of all prices in the economy. These factors, not short-run changes in demand or supply, create the long-run trend in the CPI. The month-to-month or quarter-to-quarter CPI can be quite variable withithis trend. For this reason, not every change in costs, prices, or the CPI can be attributed to inflation.
Inflation is an exception to ordinary market fluctuations in the prices of goods in that all prices are trending together. While a single rising price reflects fluctuations in one market (like petroleum), and could even show up in a higher CPI, the phenomenon of all prices, rising together over time, requires explanation. Only more money can make that possible. In our economy, only the Federal Reserve can make that possible by easing credit and creating more loans and bank deposits.
Why is this confusion between individual price changes and inflation so widespread and persistent? Several reasons: 1) most people who work in the media do not understand what inflation is; their listeners and readers are constantly exposed to misuse of terms that have a much more precise economic meaning than they present; 2) texts and materials, some from the economics profession itself, too often range in quality from
confusing, to wrong, to abysmal (often combining ‘confusing’ and ‘wrong’ in a largely nonsensical yet graphically sophisticated yet ‘teachable’ formats).
Annual inflation is up .07 percent as compared to the decade of the 1990’s—2.21 percent vs. 1.57 percent in 2000-03—according to the data, but lower on an annual basis than it was in the decades of the 1960’s (5.46 percent), 1970’s (11.39 percent), and 1980’s (4.83 percent). And current data show that from May ’05 to June ’05, the month-to-month Consumer Price Index measure dropped .1 percent.
Is there any danger to not knowing what inflation means, or that there are sometimes very different conclusions one can draw from annual vs. quarterly or monthly data? When government contracts or employee pay raises, bond issues, or other economic or policy decisions hinge on market plans for the uncertain future, inflation can play a critical role in the budgeting and planning process. Costs may rise on a particular roads project, for example, for many reasons. And in the long run, inflation could be one of them. But citing inflation as the culprit responsible for rising costs in a single industry or project is a mistake.
‘Inflation’ can also become a convenient scapegoat when we simply fail to contain costs on government projects, or fail to consider more cost-effective alternative resources, methods, or techniques. The inflation confusion is so widespread that it bears repeating, almost as often as it reappears.