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Inflation: up or down, core or non-core?

So is inflation up, or down?  And does it matter?

The other day the Australian Bureau of Statistics announced that headline inflation was now 1.5 percent for the year ended 30 June 2009.

This is the lowest figure in over a decade and well below the Reserve Bank’s target range of 2 to 3 percent.

Yet core inflation is 3.9 percent, up 0.8 percent.

 So what is going on?  And what’s the difference between headline inflation and core inflation?

Headline inflation is the movement in prices of a basket of goods and services measured over time. 

There are different measures of core inflation. One way is to remove volatile components like food and petrol.

The Reserve Bank often averages the trimmed mean and the weighted median to give itself a measure of underlying inflation. As an RBA Bulletin puts it:

 The trimmed mean is calculated as the weighted mean of the central 70 per cent of the quarterly price change distribution of all CPI components; that is, the top and bottom 15 per cent of the distribution are trimmed.

The weighted median is the inflation rate for that item which is in the middle of the total distribution of price changes; that is, it trims away all but the midpoint of the distribution so that half the component weights are on one side of the median, and half on the other.

The weighted median and trimmed mean rose by 3.6 percent and 4.2 percent respectively on a year ago.  An average of the two  gives an underlying inflation rate of 3.9 percent, up 0.8 percent on the year before. 

The RBA looks carefully at the underlying inflation rate as  a better guide to what is actually happening because it uses statistical methods to remove volatility. 

In fact underlying inflation is an attempt to exclude those goods like food and fuel which traditionally rise in price greater than other commodities and use this lower inflation figure as a way to cut workers’ living standards.

But with falling fuel prices last year, this has backfired.

So inflation is both going up and down? Yes and no seems like a fair enough answer if we factor in the fact that inflation measurements are done to benefit capital not labour.

Having a range to choose from enables the bosses to pick the lowest as the benchmark for wages and the highest for interest rates policy, for example.

The big year on year price falls were in fuel and financial and insurance services. Housing, food, health and education rose markedly.

It is underlying inflation which is important to the RBA. It is going up. In other words the trend for price increases (statistically removing the more volatile component) is up.

Yet at the same time the headline figure is down. In other words there is increased downward movement in some volatile components around a rapidly increasing core of prices. 

My take on this is we could be heading into a period  of stagflation – rising inflation in a time of increasing unemployment.  To quote from Inevitable inflation? from Fruits of Our Labour:

‘From Marxists.org:

Given that price expresses the ratio between a given quantity of a commodity and its equivalent in money, it is self-evident that inflation manifests the falling value of money, rather than the increasing value of all other commodities. Thus, the reasons underlying inflation need to be sought in factors which may be undermining the value of money.

‘In Capital (Vol I, Chapter 25) Marx discusses inflation and its relationship to the crisis of capital.

Thus, when the industrial cycle is in the phase of crisis, a general fall in the price of commodities is expressed as a rise in the value of money, and, in the phase of prosperity, a general rise in the price of commodities, as a fall in the value of money. The so-called currency school concludes from this that with high prices too much, with low prices too little money is in circulation. Their ignorance and complete misunderstanding of facts are worthily paralleled by the economists, who interpret the above phenomena of accumulation by saying that there are now too few, now too many wage-labourers. Marx, Karl. Capital, Volume I, Chapter 25. 1867.

‘Inflation has always been blamed by classical economics on the increase of workers wages. The logic being that, the more workers get paid, the more money is in the system, and therefore the less value the currency has vis-a-vis goods and services.

‘However, history has shown that in fact repeated financial bubbles lead to crisis in capital through boom-and-bust cycles which are the prime drivers of inflation. Again, from Marxists.org:

The most common cause of the loss of value of money is the creation of “Fictitious capital”, i.e., the creation of money or credit exchangeable for money without the creation of commensurate value in the form of goods and services, thus undermining the value of all forms of money and credit: for example, the excessive printing of paper money by the government to finance public works, the creation of fictitious value by banks through unsecured loans, the declining exchange rate of a country’s currency, causing prices of all imports to increase, and so forth.

Does that sound at all familiar?

Indeed it is possible that the Reserve Bank will soon raise interest rates because of underlying inflation fears thereby attacking workers living standards and perhaps increasing the drive to create more fictitious capital.

But there is something more to all of this.  Most wage increases are measured against headline inflation.

So the bosses will use that low figure to argue that we shouldn’t get any increase, or an increase around 1.5 per cent.

So too will most union leaders.

As the discussion above shows, with underlying inflation at 3.9 percent, wage increases of around 1.5 percent are effective wage cuts of over 2 percent.

Wages don’t cause inflation, just as they don’t cause unemployment.  The profit system does.

Any wage increase less than 4 percent in the coming year will be a real wage cut.  Let unions fight to defend living standards.

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Comments

Comment from Dave Bath
Time July 23, 2009 at 9:47 pm

Yep. “The Economist” for some time has been warning about increased prices for essentials (including water and power) with decreased prices for the non-essentials.
Stagflation is something I’ve been worried about. A good backgrounder (I don’t completely agree with) is from the CEPR Policy Insight 23 May 2008 “Keynes and the Crisis”
http://www.cepr.org/pubs/PolicyInsights/PolicyInsight23.pdf which predicts US stagflation, and points out the failure of macroeconomic doctrine – Ricardian equivalence broken. More contentiously: “When monetary policy comes to involve choices of inflating or deflating, of favouring debtors or creditors, of selectively bailing out some and not others, of allowing or preventing banks to collude, no democratic country can leave these decisions to unelected technicians. The independence doctrine becomes impossible to uphold.”
Hard to say where I stand on that – it’s a “heads the bastards win, tails the innocents lose” problem.
Time for a new system that focuses on human outcomes as a measure of economic success, rather than the artificial indices popular now that do not adequately reflect the needs of societies. If we used decent indicators, then capitalism (at least where essentials are concerned) would be defrocked.

Comment from Bill
Time July 23, 2009 at 10:44 pm

Thanks Dave. And some essentials like food, although they have gone down over the last year, (in part because of falling fuel prices) appear to be on the increase again. And certainly a recent study (??) concluded that food prices over the last decade or so had increase data rate of about 4 percent in real terms. (I think).

One thing I don’ think we are seeing factored in yet is a possible collapse in the price of retail goods since the stimulus package may be propping them up. That contradicts I think the stagflation guess.

One the other hand the need to recapture lost profit may force those prices to stabilise or increase.

I am thinking about another article on the causes of inflation but suspect that would be too high brow for this blog, and also I’d have to do some re-reading.

Comment from Leonie
Time July 23, 2009 at 10:53 pm

Thanks for the article too. I’ve had a quick squiz. I like his argument about independence, but that just shifts the goalposts so that elected reps make more or less the same decisions. Heads they win tails we lose, as you say.Capitalism defrocked – I like it.

Comment from Arjay
Time July 23, 2009 at 11:57 pm

Well Coles and Woolies cartel have inflated food prices.Govts who have grown with the resources boom,have now increased charges/taxes at a State level.Kevin is borrowing billions to prop our economy so we now have to service debt. We have lack of infrastructure which is making our economy very inefficient futher erroding tax revenue and quality of life.

Many people spend more than 30%
of their time travelling to and from work.They are often tired before they begin work.How can this be an efficient way to run anything?

This economy is not planned.It just raises
chaos theory to a whole new level of absurdity.

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Comment from Dave Bath
Time July 24, 2009 at 4:33 pm

As a backgrounder, I’ve found many thought-provoking articles, from both left and right, at VoxEU.org, which is tightly bound to the CEPR. It’s a bit like a kind of group blog for economics professors and researchers.
(To give you an example, a rightie and leftie once combined to argue, based on evidence from Sweden, that mandatory paternal leave improves gender equality.)