Alexei Bayer and Kenneth Silber, writing in the WSJ, say that failure of price indexes to rise more substantially discredits the economics profession (why the spate [or is it slew?] of such pieces?).
Two questions before quoting from the piece below: first, is it really low inflation when the CPI itself shows a 50% theft of dollar purcashing power since Reagan first took office? Second, what about the consumers' right to deflation?
Why That Inflation Dog Won't Bark
By ALEXEI BAYER and KENNETH SILBER
April 19, 2004; Page A21
The latest inflation figures show a 0.5% increase in consumer prices in March, a higher jump than many economists expected. But inflation overall remains remarkably low — and that should be a source of acute embarrassment for the economics profession. Indeed, it should spark a debate about the use and abuse of economic forecasting models.
In the 1970s and early '80s, inflation in the U.S. jumped into double digits and became Economic Enemy No. 1. Economists in academia, business and government conducted extensive research into inflation, making it perhaps the most-studied subject in economics. And the Federal Reserve, then under Chairman Paul Volcker, made use of their prescriptions as it hiked interest rates to wring inflation out of the economy.
Now, however, American authorities are doing everything economists have told them not to do if they want to avoid spurring inflationary pressures. The fiscal deficit is nearing $500 billion, the dollar is weak, and amid a robust recovery the Fed is keeping interest rates at 1%. Yet, the inflation dog refuses to bark. The Consumer Price Index fell to 2% in 2003 and is forecast to decline to around 1.5% this year. Strange, isn't it?
Such numbers are even stranger when you consider that many costs are still rising sharply. Home prices rose by 7.6% during 2002, and by 8.4% last year. Costs of medical care and education are rising at double-digit rates. Movie and sports tickets have gone up much faster than headline inflation, as have many tolls and public services, legal and accountant fees, and more. Gasoline prices are up by more than 50% over the past five years. And those are national averages. New York, Los Angeles and other "in demand" places have experienced substantially higher cost-of-living increases. Businesses are getting hit as well. Commercial real-estate prices are on the rise, shipping costs are up and recently there has been a jump in energy and raw materials prices.
Clearly, inflation indices are not capturing fundamental structural changes under way in the economy. To understand this, you need to look not at past patterns — as economists usually do — but at new economic reality. Over the past two decades, industry has become far more adept at providing goods and services, aided by technology and a largely pro-business global political climate.
Transportation and communications have become more reliable, and the information revolution has created real-time links among producers and consumers. Companies can now set up production facilities faster and more cheaply than ever before. The result is a massive overhang of supply over demand. Whenever or wherever new demand arises, it triggers ample new supply to satisfy it. Meanwhile, the ascendancy of big discount chains and "no-brand" products has put relentless pressure on suppliers to keep prices down.
Here is a good example of how things have changed: Back in the '80s, Rollerblade came out with an in-line roller skate. For years, it had a lock on the market, maintaining premium pricing. Only a decade later, Razor scooters created a similar craze for their product — yet within months, numerous competitors sprang up, running prices down. Many unbranded clothing and food products have actually fallen in price over the past three decades, and such items are amply registered in the consumer-goods basket that is used to measure inflation.
But in sectors where supply is limited — such as education, health care and some brand-name products — prices are going through the roof. And economists add insult to injury by telling consumers that inflation is dead and buried! This brings us back to the misuse of economics. Economists try to position themselves as hard scientists, similar to physicists or chemists. They have derived laws of economics, on which they base their advice to businesses and politicians. Physical scientists, however, derive their laws from studying controlled environments, isolating their experiments and repeating them under the same conditions. Economists don't have that luxury. Each economic cycle is unique, and has no obvious starting or ending point. Moreover, society is constantly changing in ways that are hard to understand while those changes are taking place. It's as if Galileo's famous experiment with metal balls were conducted by dropping them not from a stationary tower but from a wild ride at Disney World.
Economics is an important science, but it has allowed the political and business establishment to misuse it. Economists are asked to forecast future economic developments. They should be more forthright in saying that it can't be done. Economics is more like history than like physics. There is, for example, enough data to analyze the list of popes over some 2,000 years, and try to determine what the name of the next Bishop of Rome is likely to be. Historians could gauge the statistical likelihood of a third John Paul in a row, or see which name usually came after a John or a Paul. Fortunately, historians are not being asked to perform this sort of service — but economists are.
As for the problem of inflation, it probably is not wise of U.S. policy makers to throw both fiscal and monetary discipline to the winds. It is likely to end in tears. Just don't look to economists to tell you how or when.
Mr. Bayer is a columnist for "Vedomosti," the Russian business daily co-owned by Dow Jones, publisher of The Wall Street Journal. He and Mr. Silber are economics columnists for "Mental Floss" magazine, and co-authored the economics chapter in "Condensed Knowledge" (HarperCollins, May 2004).
