Inflation 2 Essay, Research Paper

INFLATION

Can Our Economy Grow Without It?

INTRODUCTION: What is inflation? The definition of inflation, according to Webster s Revised Unabridged Dictionary, is an undue expansion or increase, from overissue. (Hypertext, 1) Although, Webster s is considered by most to be the overall best dictionary, WordNet states the meaning of inflation a lot clearer by saying, it s a general and progressive increase in prices. (Hypertext, 1) It occurs when the value of goods rises faster than the value of money. The usual approximate measure of this is the Consumer Price Index, which weigh the prices of different goods according to importance in a typical budget and then shows how much the prices of these goods have increased. This immediately raises some problems; for example, the weight of the goods must change over time. The importance of computers was not measured in the price index 100 years ago. Another problem is the failure of the price index to capture changes in quality. The quality of a good may have improved by 20%, while the price has only risen by 10%. The consumer price index doesn t feel this should be a factor, but many would disagree. Hence, inflation is not easy to define in practice. This should be kept in mind when discussing how to defeat inflation.

DISCUSSION: There have been numerous theories on how to defeat inflation and even some theories on whether, or not, it should be defeated at all. Some say that inflation is not only expected, but often, needed. Economists believe that in order for the economy to expand and grow, there has to be some level of inflation. Therefore, the opposite holds true as well. If you want to lower inflation, you have to accept a semi-standard economy. They call this tradeoff the Phillips Curve.

The Phillips Curve is thought to be the proper way of balancing economic growth and inflation. For this reason the Federal Reserve is always looking for the perfect equilibrium at which we can maximize our economic growth while keeping inflation as minimal as possible. They do this by increasing and decreasing interest rates. Although, Economists and the Federal

Reserve abide by the Phillips Curve as a general rule for not letting inflation get out of hand, it has been proven many times in the past that it is possible to have a very healthy and prosperous economy without raising inflation at all. There are even examples of inflation declining while the economy booms.

As Steve Forbes, of Forbes magazine, said, Prosperity is not the fueler of inflation. (Forbes, 23) For example, in the 1980’s, when the economy was at a major high, inflation fell from 13% all the way to 4%. That s an incredible drop for such a short period of time. Another good demonstration of a healthy economy with low secondary effects of inflation is time period between the Korean Vietnam Wars. During this time the countries economy expanded at an annual average of 3.5% while the inflation rate stayed at a minimal amount.

Our central bank, along with the Clinton Administrations and many other major economists seem to believe that any kind of growth in the economy of over 2.5% will trigger inflation. That s why so many economists assumed that with the ever lowering unemployment rates of recent, there would be huge increases in wages and it would sharply inflate prices. This same assumption was made because of the Federal Reserve s actions in the past. In 1994 the Federal Reserve tried slowing down the economy in the fight against inflation by raising interest rates. They were not thinking of the opportunity costs of a million new jobs that could have been created, but were not, due to the economies slumping standards. Because of this, many personal incomes that could have been increased were not. This is just one example of market failure through the ideas of Phillips Curve and the Consumer Price Indexes.

As I stated earlier, the Consumer Price Indexes, that most economists go by to judge inflation, are not completely accurate. There are many goods in the market today that greatly increased their quality while maintaining or even reducing their prices. A great model for this are the new personal computers. Today s computers are more powerful and faster than the older

models of just a few years or even months ago. Somehow, through the wonders of technology, they manage to make these great new computers at lower prices than the old ones. This is just one reason why the inflation rate is so much lower than what the Consumer Price Indexes in comparison to the Phillips Curve would lead you to believe. In fact, as of 1996, the consumer price inflation was running at an annual rate of about 3 percent. It had been holding relatively steady at this percentage for the previous four years as well. That percentage was absolutely amazing considering the unemployment rate, at that time, was at a seven-year low of just over 5 percent.

CONCLUSION: From my research, I have concluded that inflation is definitely an unwanted and usually unneeded aspect of a good economy. The main concept of the Phillips Curve is fine; it just needs to be updated. They need to reevaluate the weight of the prices for the different goods. They also need to update the overall list of important goods in the typical budget (attached is a recent Consumer Price Index listing and charts). This new listing would have to include all the latest goods that weren t as important in the past. The Phillips Curve should also start taking into consideration the ratio of the quality that the good has increased to the price that it has increased. This would show a truer relation of the prices of goods to the inflation of the economy.

I can see the Federal Reserves reasoning behind raising interest rates to slow down the economy and lower inflation, but they need to realize that the rate of inflation is not completely dependant upon the rise and fall of the economies well-being. The past has proven to us numerous times that the economy is quite capable of being stable and prosperous without effecting the inflation rate in a negative way. That s why I feel that it would be in the nations best interest to continue letting the economy expand into bigger and better things without raising interest rates to unneeded proportions.

Works Cited

Forbes, Steve. Bad Idea Begets Bad Economy. Forbes. Oct. 9, 1995: p23.

Dentzer, Susan. Honey, I Shrunk the Price Tag!. U.S. News & World Report. Sept. 23, 1996: p72.

Forbes, Steve. Stop Stunting Our Prosperity. Forbes. Oct. 16, 1995: p27.

Inflation. Hypertext Webster Gateway. Jan. 20, 1999: internet. http://work.ucsd.edu:5141/cgi-bin/http_webster?inflation

Bootle, Roger. Chapter 2-Prices. The Death of Inflation. Nicholas Brealey Publishing. 1996: p488-489.