What Is Important — and Not Important — about Inflation

Issue Briefs | Economy

No. 192
Thursday, May 19, 2016
by David Ranson

From early times investors have rightly worried about the instability of the price level. Inflations large enough to wipe out real returns from stocks and bonds are all too common. Does that require that the rate of inflation be a vital consideration in investment decisions? Not necessarily. It is not so much inflation itself, but its instability or unpredictability that hardest hits investment performance. Egged on by statisticians, the Federal Reserve, pundits and the press, investors spend scarce time and resources arguing about the degree of inflation. Yet the facts suggest much of the fuss is unnecessary.

Strictly, “inflation” is a general rise in the cost of living. But in recent years the behavior of different parts of the cost of living have diverged enormously. In the goods sector, thanks to globalization and technological
advances, prices are mostly stable or falling, and quality is generally increasing. In the services sector these downward pressures on prices are much weaker. And the measurement of quantity and price is far more difficult in the case of services. It is so hard to define and measure price change it is a wonder that statisticians claim to accomplish it.

As economies develop and become more complex, the size of the goods sector declines relative to the services sector. As government grows, the size of the public and regulated services sectors grow at the expense of the competitive private market for services. For both reasons, inflation becomes less transparent and harder to define than in the past.

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