NCPA - National Center for Policy Analysis

Deflation, or Re-inflation?

March 6, 2002

Which way is inflation headed, up or down? Knowledgeable observers disagree, pointing to different ways of measuring inflation and its effect on prices.

For instance, syndicated columnist Larry Kudlow says "inflation is currently rock bottom and expected to stay there...."But Barron's columnist Gene Epstein sees "sure signs that inflation is about to accelerate."

  • Epstein points out that inflation is a monetary phenomenon measured by the growth of the money supply: in the 12 months ended January 2002, money as measured by M2 (cash and bank accounts) jumped 9.6 percent, while an "even better measure" called MZM (Money of Zero Maturity) leapt 19.1 percent.
  • But the lagging effect of monetary inflation on prices is popularly tracked by the Consumer Price Index (CPI), a basket of consumer goods and services, which rose by a mere 1.1 percent from January 2001 to January 2002.
  • Actually, many experts think the CPI overstates consumer price increases because it doesn't account for quality improvements, innovative new products or the substitution of lower priced goods for costly ones.

The CPI weights all the goods and services in the basket by their share of the consumer dollar, and then turns them into a weighted average, or mean. However, Epstein says a median CPI developed by Ohio State University economist Stephen G. Cecchetti eliminates distortions caused by the price volatility of consumer products. Cecchetti tracks the consumer good or service in the middle (median) of price changes each month.

While the CPI has been decelerating, Cecchetti's median index has been accelerating, from 3.6 percent in April 2001 to 4.0 percent by November, before ticking down to 3.9 percent in December and January.

Thus, consumer prices may rise at a slower or faster rate, or fall, depending on the strength of the economy and the demand for dollars.

Source: Larry Kudlow, "Why not inflation-targeting?" February 23, 2002,; Gene Epstein, "Blame the Median When Inflation Resurges," Barron's, February 25, 2002.


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