# Confusion about energy prices and inflation

Inflation, defined as growth General level of price, Not directly observable above the general price level (also called “overall price level”). You can’t go to your local convenience store and order a unit of GDP, “How much is it?” I mean, what is the general price level for a unit of GDP made up of a fraction of an automobile, a few words of medical advice, some of an Amazon delivery service, a dozen bubble gum, etc.? Inflation is Approximate Some “representatives” measure the average price increase of a basket of goods and services. This assumption of inflation (e.g. consumer price index or CPI) is incorrect and attempts are made to try to return to the observed individual prices of the causes of inflation, as relative price changes (between goods and services) are not included later. By inflation

Consider pronouncing the following values. The The Wall Street Journal Wrote (“Record diesel price pressure European driver, US delivery,” May 13, 2022):

Rising electricity prices are one of the main reasons for continuing inflation

The following historical observations may disprove such a claim. In the chart below, let’s focus on the period from January 1999 to July 2008. During this period the average price of energy for American consumers (calculated from a sub-index of the CPI) increased almost endlessly and was 172% higher than at the beginning of the period. However, some more prices have come down. For example, the average price of consumer durable goods (including things like cars and appliances) dropped by 12%; Clothing prices, by 10%. While inflation was estimated at 33%, some prices rose, others declined.

And to that point. Without inflation, relative prices will continue to change, some rising, others falling. The measured total change in a given price is, by definition, the sum of its relative changes (compared to other products, excluding inflation) and the rate of inflation:

Total price change = relative price change + inflation.

No one can say that the change in total price has “contributed” to inflation because inflation has already taken place. Added Total production relative price changes. If you get 3 by adding 2 (2 + 1) to 1, it doesn’t make much sense to conclude 3 “contributions” to 1 (except in a very formal mathematical way).

It is true that if the shock of supply reduces the production of oil and thus reduces the production of all consumer goods that use these inputs, there will be a one-time increase in the general price level because the same amount of money will be left behind. But why inflation will continue month after month, year after year, as we see the CPI in our charts. A sustained inflation (which people usually refer to as inflation) requires more new money behind the amount of existing (or a forty reduced) product.

This argument is based on the standard microeconomic theory (which relates to relative prices and is therefore also called “price theory”) and on a macroeconomic theory called monetaryism. But keep in mind that any counter-claim must be based on some economic theory, otherwise it is just a vague ad hoc insight. The media and alas even the financial press often relies on the latter.

Over the past few decades, the Milton Friedman type of monetaryism has been abandoned or replaced by economists. But this does not necessarily make it illegal, especially since its fundamental consequence is that an increase in money supply above and beyond the public’s demand for money will, after a reversal, create inflation. (I understand that co-blogger Scott Sumner has defended a modified version of monetaryism, which does not seem to contradict my above claim, at least under normal circumstances.)

A recent article by John Greenwood (Invesco, Ltd.) and Steve Hank (Johns Hopkins University) presents an argument close to the above mine: “Economic growth and inflation in advanced economies, 2021-2022: relative prices and overall price levels,” Applied Corporate Finance Journal 33: 4 (2021) A paragraph from the abstract of the article provides a good summary:

The authors argue that this is unanimous [on current inflation being largely generated by “supply chain disruptions”] Failure to distinguish between relative price change and overall price level change will prove it wrong. The movement of any single set of relative values ​​fails to provide information on the overall rate of inflation. And the amount of money is confirmed by theory, the overall inflation rate and price level are determined by changes in money supply measured in detail. On the other hand, changes in relative prices, changes in demand and supply in the real economy, make them free from changes in money supply. Thus, doubling the money supply will double all nominal value, relative values ​​will not be affected by monetary policy.