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CHAPTER 6 POLICY GOALS: PRICE STABILITY |
"The significance of the great expansion of the 1960s lies not only in its striking statistics of employment, income and growth but in its glowing promise of things to come. If we can surmount the economic pressures of Vietnam without later being trapped in a continuing war on inflation when we should again be fighting economic slack, the 'new economics' can move us steadily toward the qualitative goals that lie beyond the facts and figures of affluence."Walter Heller
I. Definitions and Construction of a Price Index
The Employment Act of 1946 mandates price stability as the third of three macroeconomic goals. Price stability starts with measurement of an economy's general level of prices.
The general level of prices is measured with a price index. A price index is a composite of prices at a point in time.
Construction of a Price Index
First, select a "basket of goods" for which the price index is to be calculated. Sum the prices for each year. Then, select a base year, e.g., 1992. (In the table below, the base year is Year 1.) Divide the current year prices by the base year prices and multiply by 100.
Sum of Base Year Prices
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Price stability is measured by the annual percentage change in the price index.
P = (P1 - P0)/P0Inflation is an increase in the general level of prices, as measured by some price index. Notice that not all prices rise during an inflation. Some prices may be falling, but those prices which are rising tend to pull up the general level of prices. In Year 2, above, the price of Good C actually fell $1.00, but the overall level of prices increased 10.0%.
Deflation is a decrease in the general level of prices, as measured by some price index. Notice that not all prices fall during an deflation. Some prices may actually be rising, but those prices which are falling tend to pull down the general level of prices. In Year 4, above, the price of Good B actually rose by $1.00, but the overall level of prices fell by 8.7%.
Disinflation is a decrease in the rate of inflation. In Year 2, above, the general level of prices rose by 10%. In Year 3, prices rose again, but by a smaller amount, only 4.5%.
Disdeflation is a decrease in the rate of deflation. In Year 4, above, prices fell by 8.7%. The following year, they fell by only 4.8%, and in Year 6, prices declined, on average, only 2.5%.
II. Measuring Performance
The general level of prices and price stability are measured with several different price indexes.
The Consumer Price Index (CPI) measures the general level of prices paid by households for goods and services. It is calculated each month on a national as well as several regional bases.
The Core Consumer Price Index(CCPI) measures the general level of consumer prices, but excludes components whose prices are extremely volatile and vary for unpredictable reasons from period to period, for example, food and energy prices.
The Producer Price Index (PPI) measures the general level of prices paid by businesses for raw materials, semi-finished goods, and capital equipment. It is calculated each month. Some element of double counting is evident as raw materials are also entered as semi-finished goods. Movements in the PPI tend to forecast future movements in the CPI and the Implicit GDP Deflator, because changes in factor input prices are eventually passed along to consumers and government buyers.
The Core Producer Price Index (CPPI) measures the general level of producer prices, but excludes components whose prices are extremely volatile and vary for unpredictable reasons from period to period, for example, food and energy prices. Movements in the CPPI tend to forecast future movements in the CCPI and the Implicit GDP Deflator, because changes in factor input prices are eventually passed along to consumers and government buyers.
The Employment Cost Index (ECI) measures the general cost of hiring labor and includes labor's wages, salaries, fringe benefits, and perks. Movements in the ECI tend to forecast future movements in the CPI and the Implicit GDP Deflator, because changes in labor costs are eventually passed along to consumers and government buyers.
The Implicit GDP Price Deflator measures the general level of all prices. It includes components of the CPI and the PPI as well as the cost of construction and government and imported goods.
III. Measurement Problems
Problems in Computing a Price Index
Regional differences Prices in major metropolitan areas tend to be much higher than prices in rural areas and the Mid-West. The composite price index cannot adequately reflect both sets of prices at the same time. Therefore, the Census Bureau has opted to calculate the Consumer Price Index, for example, from a random sampling of prices for an average "market basket of goods and services" bought by the average family of four living in a city. This procedure is faulty and tends to inflate the CPI, because it is heavily weighted by the higher prices in the major urban areas. It also fails to capture the differences in market baskets between city-dwellers and country-dwellers.
Arbitrary weighting Weighting becomes arbitrary because a small percentage increase in a large item will raise the index by more than a large percentage increase in a small item. If, for Year 2, the price of Good A rose by a small 10% or $1.00, all other prices remaining the same, the new index would stand at 105.0, a 5% increase in the general level of prices. On the other hand, a 50% increase in the price of Good B to $1.50, ceteris paribus, raises the index to only 102.5, a mere 25% increase in the general level of prices.
Temporal incongruity Construction of the index assumes that one buys a new automobile or a new house each month. In 1978, the CPI was revised and, at that time, adjusted to reflect rents rather than housing prices, per se; but even rents do not rise each month for the average family of four living in the city! The BLS again revised the index in 1987 to reflect substantial changes in the composition of the average family's market basket.
The Price Index as a Measure for Other Adjustments
The CPI is used for wage negotiations To the extent that the CPI goes up, so do wage demands and payments to Social Security recipients. To the extent that the CPI overstates the representative market basket for the average family, wages will rise faster than productivity gains, thus pushing prices still higher.
The CPI is used to adjust Social Security payments To the extent that the CPI goes up, so do payments to Social Security recipients. To the extent that the CPI overstates the representative market basket for senior citizens, aggregate demand by will rise, thus pulling up prices further.
The Need for Periodic Revisions
Changes in the quality of goods in the market basket Over time, manufacturers improve the quality of products. Quality changes are not necessarily reflected in proportionate prices changes. For example, today's side-by-side frost-free refrigerator with automatic ice maker and ice crusher are a far cry from the ice box at the turn-of-the-century. Today's automobile with air conditioning, cruise control, steel-belted radial tires, built-in CD player with quadraphonic sound, and dual air bags is no comparison to even Henry Ford's popular Model T.
Changes in the composition of goods in the market basket Over time, people discard older, out-date items from their market basket and update with new products. For example, at some point, wooden wagon wheels got deleted and steel-belted radial tires added. The crystal radio was eventually replaced by SONY CD-Walkman. Similarly, today's average market basket includes a personal computer, compact disk players, and VCRs, all unheard of 15-20 years ago. Recent Revisions
The Census Bureau made several revisions in 1978, 1987, and 1992. The 1987 revision, in particular, made several major changes. Many factors contributed to the need for revision, including differences in consumer buying habits as well as prices, population shifts in age and location, new technology and products, and new category definitions.
- The new price index reflects the increased number of two-income families, singles' households, and elderly people as well as other demographic changes over the last nine years.
- It reflects more spending on physical fitness; eating out, especially in fast food restaurants; new products such as compact disk, stereo, and big screen TV equipment; the impact of energy conservation; and the population gains of the Sun Belt.
- It reflects the decline in consumption of red meat (and the increased popularity of poultry and fish); the decline in the demand for sugars and sweets, as a result of families with fewer children who are the biggest buyers; and a decline, for the same reason, in school lunches, while dinners away-from-home increased.
- Transportation expense dropped considerably as a result of lower fuel prices and more fuel-efficient vehicles.
- For the first time, in the 1987 revision, the service sector accounted for more than half of all spending, up 6 percentage points to 52% from 46% in the 1978 revision. Spending on commodities and goods has slipped to 48%. One implication of this trend is that wages, fees, and salaries will be the dominant influence on future inflation levels.
IV. Causes of Price Instability
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Demand-pull inflation is when increased spending pulls up prices faster than businesses can increase output. An increase in aggregate demand from AD0 to AD1 pulls up prices from P0 to P1 along AS. Competitive bidding for relatively scarce goods and services pulls up prices. If the economy is not at full-employment, demand-pull inflation increases output and reduces unemployment. At full employment increased spending results in pure inflation. The causes of demand-pull inflation are several:
- Consumers may dishoard past saving.
- Consumer credit may be too liberal.
- Government deficits may be too large.
- Commercial and bank credit may be excessive.
- Money supply may be increasing to rapidly.
- The dollar may be falling too fast.
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Cost-push inflation is when increased costs of factor inputs in excess of productivity increases push up prices. Wages, material costs, capital, land, and interest expense increases are passed along to consumers via administered prices (monopolistic elements) and cost-plus or mark-up pricing.
d/dt (ln w) = d/dt (ln p) + d/dt (ln MPL).
%
w = %p + %MPL%
p = %w - %MPLA decrease in aggregate supply from AS0 to AS1 pushes up prices from P0 to P1 along AD. Cost-push inflation reduces output and increases unemployment.
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Demand-push deflation is when decreased spending depresses prices. A decrease in aggregate demand from AD0 to AD2 pushes down prices from P0 to P2 along AS. Deficient demand and competitive selling pressures combine to reduce the glut of goods and services by pushing down prices. If the economy is at full-employment, demand-push deflation increases unemployment, as firms attempt to adjust inventories and production before prices. At higher rates of unemployment, decreased spending results in pure deflation. The causes are several:
- Consumers may increase saving.
- Consumer credit may be too restricted.
- Government surpluses may be too large.
- Commercial and bank credit may be tight.
- Money supply may be contracting or increasing too slowly.
- The dollar may be rising too fast.
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Cost-pull deflation is when decreasing factor costs and/or changes in technology pull down prices. Increased supply and competitive selling pressures combine to reduce the glut of goods and services by pulling down prices. An increase in aggregate supply from AS0 to AS2 pulls down prices from P0 to P2 along AD. Cost-pull deflation increases output and reduces unemployment.
Structural Inflation
Structural inflation (bottleneck inflation) is when temporary increase in the general level of prices due to downward stickiness of prices in markets for which demand is declining. Inflexibility and immobility among the factors of production and contracted factor costs permit prices to rise faster in industries where demand is increasing than they tend to fall in industries where demand is declining. Imperfect markets create a temporary bottleneck, until resources can be reallocated according to changing demands.
V. Consequences of Price Instability
Consequences of Inflation Benefits debtors and those whose incomes depend on prices, e.g., labor (wage income), home owners, antique and art collectors. Debtors, in particular, gain because they repay cheaper dollars. They gain because they bought and financed at yesterday's lower prices and interest rates.
Hurts creditors and those on fixed incomes, e.g. lenders, bondholders, pensioners. Creditors receive cheaper dollars in repayment and cannot purchase the same amount of goods and services as before they made their loans. Pensioners, bond holders, and other fixed-income recipients lose purchasing power as prices rise, but income does not.
Distorts the pattern of resource usage Time is wasted moving resources between and among alternative uses, as some prices rise faster than others. Since inflation tends to redistribute purchasing power, inflation distorts relative demands, resource allocations, and the pattern of development. For example, a low interest rate, deflationary environment tends to promote the development of interest-sensitive sectors, such as automobiles and housing. When the movement reverses itself, the economy is left with overproduction and a waste of resources in the over-built sectors and not enough resources to expand production in the under-built sectors.
A little inflation (chronic inflation) may actually be good for an economy. It tends to promote economic growth by allowing prices and profits to rise faster than wage costs. Businesses are more willing to expand output in response to these profits.
Rapid inflation (hyperinflation) is bad for en economy. It forces a flight from money into physical goods. Hyperinflation generally terminates in a barter system and stagnation.
Consequences of Deflation
Benefits creditors and those on fixed incomes, e.g. lenders, bondholders, pensioners. As prices fall, the purchasing power of interest and principal repayments from lending and fixed income from pensions increases.
Hurts debtors and those whose incomes are tied to prices, e.g., labor (wage income), home owners, antique and art collectors. Debtors, in particular, repay debt in more expensive dollars and lose the opportunity to purchase goods and services at the lower prices.
Distorts the pattern of resource usage Time is wasted moving resources between and among alternative uses, as some prices rise faster than others.
A little deflation (chronic deflation) may actually be good for the economy. Falling prices increase purchasing power as prices tend to fall faster than wage income.
However, a deflationary environment is more threatening for the economy than inflation. Even though consumers like to see falling prices, the inability to raise prices depresses businessmen's expectations. Capital spending and wages fall. Rapid deflation cuts profits and firms respond by cutting production levels, laying off workers, and increasing the pool of unemployed. The end result is depression and stagnation.
VI. Optimum Amount of Price Stability
No one likes roller coaster prices. They tend to distort individuals' behavior patterns and the pattern of resource allocation. When prices swing widely, much time is wasted rearranging resource usage, only to find old patterns repeated. Except for relative shifts in prices in response to changing tastes and preferences and resource availability, the general level of prices should remain fairly stable. Such stability permits more accurate decisions concerning today's choices and tomorrow's opportunities. But, what exactly constitutes stability?
Price Stability
According to Alan Greenspan, Chair of the Federal Reserve Board of Governors, price stability exists when inflation is not a consideration in household and business decisions. Unfortunately, this answer begs the question, because it fails to identify a target of any known achievable consequence. How does one know when inflation is not a consideration in household and business decisions? Take a survey? In different countries, at different times, the survey will yield different results. In some countries, households and businesses have lived very comfortably with double-digit rates of inflation. In others, the slightest hint of price rises causes households and businesses to rearrange their decisions. Therefore, policy makers need objective quantifiable measures of price stability to guide them in achieving this goal.
Price stability is when prices fluctuate within some socially acceptable range or narrow band. For example, a target of 0% to 2% allows for prices to rise or fall by as much as 2% per annum. This implies, however, that the general level of prices is free to fall as well as rise and that a prolonged or severe deflation is just as bad as a prolonged or severe inflation.
Price Instability
Price instability is when prices fluctuate outside the socially acceptable range. In the above example, an inflation rate of 4% or a deflation rate of 3% is unacceptable and indicative of price instability.
While no policy maker has specifically identified an acceptable range, the consensus in 1946, at the time Congress passed the Employment Act, was that a minimum rate of unemployment of 4.0% could be sustained, if inflation were no greater than 2.0%. Fifty years later, the U.S. economy appears poised to achieve this benchmark.
VII. Current Trends
Post World War II to Mid-1960s
In the period immediately following WW II, prices in the U.S. remained relatively stable. Neither inflation nor deflation plagued the economy. Throughout the 1950s, prices never rose by much more than 1.0% per year. This period of slowly rising prices gave rise to the concept of chronic inflation.
Mid-1960s to Early 1980s
In the mid-1960s, however, higher rates of inflation began to plague the economy. It started with a demand-pull inflation spawned by increased government spending on both the Viet Nam War and social programs to build President Johnson's "Great Society." Once prices began to rise, the spiral was fueled, on the demand side, by inflationary expectations that kept current consumer spending buoyant in anticipation of tomorrow's higher prices, by low real interest rates and rates of return, in general, and by inflationary expectations that forced individuals to shift from financial assets into real assets (such as real estate, precious metals, and art). It was also fueled by a cost-push inflation, on the supply side, spawned by two successive increases in the price of oil (one in 1973; the other in 1979), by strong labor unions exacting wage increases in excess of productivity gains and COLA clauses in anticipation of price increases, and by a weak dollar.
Early 1980s to Mid-1980s
The inflationary spiral of the 1970s peaked in 1981 at a 13.5% per annum increase in consumer prices and ended with two back-to-back recessions in the early 1980s. A tight monetary policy, engineered by the Federal Reserve, under the leadership of its Chair, Paul Volcker, helped to wring inflation out of the economy. Since then, disinflation has set in and inflation rates have trended downward. A primary reason for this disinflation was a strengthening of the U.S. dollar. An increase in the value of the dollar makes imports cheaper. When imports are relatively cheap, U.S. businesses have a harder time raising their own prices. Thus, the rate of inflation decreases.
Mid-1980s
In 1986, the CPI rose by only 1.9%, the smallest annual increase since a annual rise of only .7% in 1961. In some respects this rate was an anomaly, because it was due solely to falling oil prices. The core rate of inflation for the year was 4.0%. During this period, Iran and Iraq were at war. When it appeared that Iran might win the war, Saudi Arabia, who despised the political regime of the Ayatollah Kouhmeni, flooded the market with oil to purposefully depress oil prices and deprive Iran of revenues. Once the threat abated of Iran's success abated, Saudi Arabia cut back its production and sale of oil on the international market and oil prices rose to their previous levels. The inflation rate of 3.7% in 1987 partly reflects this rise in the price of oil.
Mid-1980s to 1990
After 1986, prices began to rise at a more rapid rate. The reasons for this increase are varied:
A decline in the value of the U.S. dollar Following a meeting of the Group of Five, FN1, in September 1985, the value of the dollar fell significantly against the currencies of major U.S. trading partners. It fell by over 40% against the Japanese yen and the West German mark. Throughout 1985 and 1986, exporters from these countries kept prices down by cutting profit margins to maintain sales and market shares in the U.S. When foreigners refuse to raise prices, domestic producers find that it is more difficult to raise prices on their own goods and services. However, by early 1987, many of these profit margins were squeezed to zero and foreign exporters to the United States began to raise prices. When prices on U.S. imports increase, domestic producers have more leeway to raise prices on their own goods and services.
An increase in oil prices By early 1987, it also appeared that the members of OPEC has settled their differences and were about to agree on a new higher price for oil. At its general meeting in 1987, the member countries agreed to stabilize the price of a barrel of oil at US$18.00. This support price was about 50% higher than the average price of $12.00 per barrel in 1986. This jump also added to the price increases generated by rising import prices.
An increase in raw materials prices Climatic changes over the period adversely influenced raw materials prices. In the spring of 1987, the Commodity Research Bureau (CRB) reported that its Commodities Futures Index, which tracks 26 raw materials prices, rose by 14.6%. This rise was the single largest increase since the summer of 1974. Near-term supplies of copper became tight and technical buying pulled up copper prices. Oil prices rose on the prospect that OPEC would raise prices again at its 1987 meeting. Coffee prices rose on rumor of a freeze in Brazil (although later it was learned that the cold spell occurred 700 miles from the coffee plantations!). Rising in tandem (and in sympathy) with the above commodities prices were gold and silver prices. Precious metals are generally considered hedges against inflation, such that any hint of renewed inflation from increases in other commodities prices sends traders scurrying to the precious metals markets. Commodities prices take approximately 6-12 months to work their way through the production process to goods that reach the consumer. Speculation of impending increases in the inflation rate began to creep back into people's expectations.
Lack of excess capacity Throughout the late 1980s, capacity utilization rates climbed. By year-end 1988, the rate had reached 85.1%, the highest rate since December 1978, when factories were functioning at an 86.9% rate. Capacity utilization for durable goods --- expensive items that are expected to last more than three years --- stood at 83.5%, while the rate for nondurable goods reached 86.9%. Some basic materials producers were operating at full capacity: The paper and paper products industry was at 94.6% of capacity, primary metals at 91.6%, textiles at 90.6%, chemicals at 89.2%, petroleum products at 89.1%. and rubber and plastics at 88.5%. Historically, an aggregate capacity utilization rate of 85% is the flashpoint for an increase in the rate of inflation. These above-optimum rates increased concerns over inflation.
The 1990s and the Future
Is it time, once more, to worry about inflation? No. The last rise in inflation rates peaked in 1990 at an annual rate of 5.4%. The core inflation rate peaked that same year at an annual rate of 5.0%. Since then, both rates of inflation has trended downward. For the last five (5) years the overall inflation rate has not gone above 3.0%, and the core inflation rate has remained below the 3.0% rate for the last three (3) years.
By all indicators, the U.S. economy appears to have entered a period of relative price stability. Except for the relatively weak value of the dollar, the 1980s and the 1990s are a lot different than the 1970s. Moreover, unless the value of the dollar falls again, its weakness alone should not give rise to any additional inflation. The rate of inflation changes only in response to changes in the value of the dollar and not in response to its relative strength or weakness.
The following factors are expected to keep inflation rates low for the foreseeable future:
Energy conservation and a weakened OPEC Energy conservation on the part of oil-importing countries has severely dampened the 1990s demand for oil, and the OPEC organization is not so strong as it was in the 1970s. In fact, OPEC has disintegrated in all but its name. Differences among members regarding quotas and revenues keep the organization from achieving its stated goals. First of all, Saudi Arabia, the marginal producer, is less willing to restrict its output and revenue for the benefit of other members, especially Iran. The Arab ethnic bond is not so strong as it once was, given increasing differences among Arabs over relationships with Israel. Second, some of the member countries, especially Nigeria, have large foreign debts to repay and have cheated to gain revenue at the expense of other members. Third, non-OPEC countries, like Mexico, have also been anxious to export oil at lower prices to gain revenue for debt repayment. Finally, the North Sea explorations of the 1970s and the completion of the Alaskan pipeline have resulted in increased supplies of non-OPEC oil. Energy shocks, like those of the 1970s, are not so likely to occur in the near future, given the size of the surplus that now exists.
Domestic excess capacity During the late-1980s, the annual average capacity utilization rate never went above the critical "flashpoint" of 85%. At its peak, in 1988 and 1989, the capacity utilization rate remained , on average, more than one percentage point below the "flashpoint". The biggest difference between the 1970s and the 1980s expansions was that during the 1980s not all industries operated at the same high rate. Much of the 1980s expansion was characterized by a "rolling stock;" that is, not all industries reached capacity limits at the same time. As the separate industries reached capacity their firms added to their capital stock. This gradual increase in capital kept the average rate of capacity utilization from rising as rapidly as during other expansions and allowed for a more orderly progression of capital formation that should keep the lid on inflation in the coming years.
Worldwide excess capacity Most commodities are in excess supply. In the mid-1970s, there were a world-wide shortages of several key commodities, like oil and sugar, and their prices soared. Currently, neither oil nor sugar nor any other basic raw material was in short supply and the prices on most of these basic commodities, even though they had risen since the mid-1980s, remained at or near historic lows.
A stable Commodities Price Index In the late 1980s, the gap between the Consumer Price Index and the Commodities Price Index was almost twice as large as in 1983. Raw material (or crude materials) prices remained very low compared with previous years, and much below the finished goods index. A drought in the midwest during 1988 forced up the prices of many food commodities, like wheat and corn, but such climate-related supply imbalances are to be expected and they are generally and quickly reversed under more favorable climatic conditions. In fact, by early 1989, the CRB Commodity Price Index had fallen back to the 230-240 range, comparable to its 1985-1987 levels. More recently, during 1996-1997, the Commodity Price Index has been fluctuating within the 235-255 range. This range is consistent with a low-inflation environment.
Limited wage gains The employment cost index has slowly but steadily declined. Wage and compensation gains slowed to 3.1% in 1987, compared with 12% in 1981. Subsequently, they rose to a rate of gain of 4.9% in 1990, but these gains have since abated to a rate of approximately 2.5% per year. Labor accounts for over 60% of all production costs. However, labor's position has been much weakened as a result of increased competition from foreign products. In 1974, the Bureau of Labor statistics reported 424 work stoppages of 1000 or more workers. In 1985, the number of stoppages fell to a low of 54, and in 1986, there were only 69. In 1976, COLA clauses were found in 61% of all labor contracts. By 1985, the number had dropped to 49% and, by 1986, to 40%. Many unions have been forced into wage freezes and concessions. Much of the "wage push" element of the 1970s inflation has dissipated, even as unemployment has fallen.
Outsourcing Many domestic firms have taken to "outsourcing" --- turning to non-union shops in the US. and abroad for parts that they once manufactured themselves. Outsourcing is an important way of alleviating restraints on domestic productivity and of keeping resale prices low.
Over-leveraged consumers Consumers are highly leveraged. By the end of 1986, consumer installment debt had reached a record high 20% of personal income. When mortgage debt is added, the figure is over 100%. While these rates have fallen somewhat in the last ten (10) years, consumers still tend to buy on credit and to remain highly leveraged. As a result, demand-pull inflation from the household sector is rather unlikely, as individuals periodically try to buy down debt rather than increase debt-financed purchases, unless the banks and credit card companies loosen their credit standards and expand credit lines.
A stable exchange rate for the U.S. dollar The value of the U.S. dollar has stabilized and has even risen 10%-20% from its lowest value against the currencies of its major trading partners. Several GATT, FN2, conferences, which reduced trade barriers, and the passage of NAFTA, FN3, which eliminated all trade barriers among Mexico, Canada, and the United States, have kept import prices from rising.
The down-side of a long wave Most world economies are past the peak of a long wave. This means that deflation will be more of a problem than inflation. After each recession (depression?) on the downside of a long wave, prices and interest rates tend to rise. However, each rise peaks at a rate below the prior peak. The U.S. experience such a rise in inflation and interest rates from 1986 to 1990. Starting with the 1990-1991 recession, both rates trended down again. Currently, the U.S. is experiencing its longest sustained period of low inflation and low interest rates. If the first quarter of 1997 is any indicator of the future, the inflation rate for the entire year could well be below 2.0%, and interest rates, as measured by the rate on the U.S. government's 30-year bond, should stay below the critical 7.0% mark.
A cautious Federal Reserve The Federal Reserve, under the leadership of its current Chair, Alan Greenspan, has been extremely cautious. Mr. Greenspan is not an ideologue, but rather a pragmatist. The Federal Open Market Committee (FOMC), the official policy-making "arm" of the Federal Reserve, has adopted this pragmatic philosophy in its approach to setting monetary policy. It watches neither the rate of growth of the money supply (a Monetarist philosophy) or interest rates (a Keynesian philosophy). Instead, it has focused on the entire economy for signs of increased inflation. When such signs have appeared, the FOMC has acted promptly to raise interest rates by one-quarter of a percentage point (or 25 basis points). On a few occasions, the FOMC has acted preemptively to thwart pending increases, even though the business community disagreed with such moves. If the Greenspan tenure is remembered for one thing, it will be the "nudging" of interest rates up and down by a quarter of a percentage point each time it acted. Footnotes
FN1 The Group of Five consisted of the heads of the central banks of Great Britain, France, Germany, Japan, and the United States. The meeting was specifically held to outline a cooperative plan between and among these countries for the purpose of lowering the value of the U.S. dollar. The agreement which emerged from this meeting is known as the Plaza Accord.
FN2 GATT stands for General Agreement on Tariffs and Trade. Prior to perestroika, most countries of the Western world were members. Today, countries which were former members of the Soviet Union, are also members.
FN3 NAFTA stands for the North American Free Trade Agreement.
VIII. Summary
Readings
The New Inflation: Causes, Effects, Cures, G.L. Bach, Prentice-Hall, Englewood Cliffs, NJ, 1972
Inflation: Money, Jobs, Politicians (Policies and Performance: Nixon through Carter), Raburn M. Williams, Arlington Heights, IL: AHM Publishing Co., 1980
Inflation Expectations and Money Growth In the United States, Donald J. Mullineaux, American Economic Review, LXX(1) Mar 1980: 149-61
Fiscal Policies, Inflation, and Capital Formation, Martin Feldstein, American Economic Review, LXX(4) Sep 1980: 636-50
Supply-side Inflationism, Leland B. Yeager, Policy Report (Cato Institute), VII(6) Jul/Aug 1984: 1-6
The Rigidity of Prices, Dennis W. Carlton, American Economic Review, LXXVI(4) Sep 1986: 637-58
Commodity Prices and Inflation, Fred Furlong and Robert Ingenito, Economic Review, (FRBSF), 1996(2)
The Costs and Benefits of Price Stability: An Assessment of Howitt's Rule, Daniel L. Thornton, Review (FRBStL), 78(2) Mar/Apr 1996, with data files
Inflation Targets: The Next Step for Monetary Policy, Mark S. Sniderman, Economic Commentary (FRBClev), 1 Aug 1996
Inflation Targeting, Chan Huh, Economic Letter (FRBSF), 97(4) 7 Feb 1997
Maintaining a Low Inflation Environment Has Come, John B. Carlson, Economic Commentary (FRBClev), 1 Mar 1997
Are There Good Alternatives to the CPI? Charles Steindel, Current Issues in Economics and Finance (FRBNY). 3(6) Apr 1997
Should Monetary Policy Focus on "Core" Inflation? Brian Motley, Economic Letter (FRBSF), 97(11) 18 Apr 1997
Bias in the CPI: 'Roughly Right or Precisely Wrong' Brian Motley, Economic Letter (FRBSF), 97(16) 23 May 1997
The Commission Report on the Consumer Price Index: Commentary, Griliches, Zvi, Review (FRBStL), 79(3) May/Jun 1997
Inflation Measurement and Inflation Targets: The UK Experience, William A. Allen, Review (FRBStL), 79(3) May/Jun 1997
Measuring Short-Run Inflation for Central Bankers, Stephen G. Cecchetti, Review (FRBStL), 79(3) May/Jun 1997, with Commentary, by Alan S. Blinder, and Commentary, by Mark A. Wynne
Quality Change in the CPI, Charles R. Hulten, Review (FRBStL), 79(3) May/Jun 1997, with Commentary, by Per Krusell and Commentary, by Robert J. Gordon
A Bureau of Labor Statistics Prespective on Bias in the Consumer Price Index, John S. Greenlees, Review (FRBStL), 79(3) May/Jun 1997
On Defining Real Consumption, Edward C. Prescott, Review (FRBStL), 79(3) May/Jun 1997
Alternative Strategies for Aggregating Prices in the Consumer Price Index, Matthew D. Shapiro and David W. Wilcox, Review (FRBStL), 79(3) May/Jun 1997, with Commentary, by W. Erwin Diewert, and Commentary, by Peter Howitt
Wage Inflation and Worker Uncertainty, Mark E. Schweitzer, Economic Commentary (FRBClev). 15 Aug 1997
Inflation Targeting: Lessons from Four Countries, Frederic S. Mishkin and Adam S. Posen, Economic Policy Review (FRBNY), 3(3) Aug 1997
A Framework for the Pursuit of Price Stability, William J. McDonough, Economic Policy Review (FRBNY), 3(3) Aug 1997
What is the Optimal Rate of Inflation? Carl E. Walsh, Economic Letter (FRBSF), 97(27) 12 Sep 1997
What is the Optimal Rate of Inflation? Timothy Cogley, Economic Letter (FRBSF), 97(27) 19 Sep 1997
On the Origin and Evolution of the Word Inflation, Michael F. Bryan, Economic Commentary (FRBClev), 15 Oct 1997
Is There an Inflation Puzzle? Cara S. Lown and Robert Rich, Economic Policy Review (FRBNY), 3(4) Dec 1997
Problems of Price Measurement, Alan Greenspan, Annual Meeting of the American Economic Association and the American Finance Association, Chicago, IL, 3 Jan 1998.
Economic Forecasting, Laurence H. Meyer, Downtown Economics Club 50th Anniversary Dinner, New York, NY, 3 Jun 1998
Canada's Money Targeting Experiment, Paul Gomme, Economic Commentary (FRBClev), 1 Feb 1998
Inflation Targeting, Edward M. Gramlich, Charlotte Economics Club, Charlotte, NC, 13 Jan 2000
Greenspan Rejects Idea of Inflation Target, Bloomberg News, New York Times, 12 Oct 2001
The Historical and Recent Behavior of Goods and Services Inflation, Richard W. Peach, Robert Rich, and Alexis Antoniades, Economic Policy Review (FRBNY), forthcoming
Websites
Consumer Price Index, BLS. Current.
Consumer Price Indexes, BLS. Current and Historical series.
Announcement to Users of CPI Data, re: Revisions in the CPI, BLS.
Monthly Consumer Prices Indexes, FRBStL (FRED). Historical series.
Prices, FRBDal (Source: BLS). Charts and historical series of CPI, PPI, and Implicit GDP Deflator.