Macroeconomics, KrugmanWells Chapter #16 Page 1 ... - Rasco.name

Macroeconomics, Krugman­Wells
Chapter #16
Page 1
Question: Since inflation measures the cost of living,
what is the value of measuring the core rate of inflation which excludes food and
energy, goods that everyone must continue to buy?
Paul Krugman: The whole issue of the core rate of inflation has actually been the
subject of a pretty funny debate in the last, last couple of years.
That’s because, actually, we've been in a situation where energy prices, in
particular, have gone up a lot;
the effects of hurricane Katrina and hurricane Rita have led to high gasoline
prices, high natural gas prices;
some food items also going up quite a lot in price. And so, you have this headline
rate of inflation, as people say:
the regular consumer price index going up pretty fast; at the same time, the core
rate of inflation, excluding food and energy, going up much less fast.
And when people said, “Well, okay, core inflation is still under control,” there’s
been a lot of caustic remarks about how, well,
there’s no inflation if you don't count the inflation. But there’s actually a reason,
there’s a very good reason for focusing on core inflation.
It goes back to some of the things we discuss in Chapter 16. When we think about
how inflation works, we—in a moderate inflation,
moderate­to­low­inflation economy like the United States, the really serious issue
is not whether you have inflation for a few months or even for a year or two;
it’s when inflation gets built into expectations and develops a kind of inertia—and
then, this can be very, very hard to bring it back down.
That’s the story of the 1980's: we had allowed inflation to get built into
expectations;
and then, there was an extremely painful process of squeezing the inflation out of
the economy, which involved a period of very high unemployment.

Macroeconomics, Krugman­Wells
Chapter #16
Page 2
Most economists working in this area (certainly, the economists at the Federal
Reserve) believe that the core rate of inflation,
leaving out the food and energy prices, is a better measure of the part of inflation
that's got inertia—the part that once it's gotten up is hard to get back down.
The idea is that nobody thinks that the result, the inflation that results from the
price of gasoline going from two dollars to three dollars temporarily,
as the result of a hurricane—nobody is going to build that into their expectations.
But a more sustained increase in prices that doesn't reflect food and energy,
that reflects all kinds of things, is a much better measure of the kind of thing that
once you got that up there, it's hard to get back down.
So, if the inflation rate goes briefly from two to four percent because of food and
energy—no problems.
If the inflation rate goes from two to four percent because, even though food and
energy prices have been going no place in particular,
that’s much more of a source of worry because it may be quite difficult to get
those extra two points of inflation back out of the system.