Why the 'gas and groceries' approach to inflation makes no sense

During most of the Obama presidency, conservatives have been fretting about incipient inflation. In 2009, the Wall Street Journal editorial page suggested an inflationary spiral was just around the corner. The following year, a whole slate of conservative economists and opinion leaders signed an open letter to Fed Chairman Ben Bernanke warning of rising prices. Stat-juking website Shadowstats went furthest of all, suggesting that government inflation indices are a hoax, and that true inflation is somewhere between 8 percent and 10 percent.

But the inflation paranoiacs often have no framework for understanding even basic concepts about inflation. Furthermore, they never seem to follow their logic through to its own conclusion: if they are right about inflation, then they are calling for higher unemployment and fewer jobs.

For example, here's Sean Davis berating reform conservatives like Jim Pethokoukis for arguing that inflation is not a problem:

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The cost of food, medical care, and education are up much more than wages, he argues. And he's probably right! But inflation is a general phenomenon — you have to look at all prices. Prices of electronics, for instance, are way down. That is why the Bureau of Labor Statistics, using a complicated averaging procedure, shows inflation to be quite low.

Inflation is a general rise in prices, and prices are set through the operation of supply and demand. For the most part, if prices are rising across the board, we must have either a shortfall of aggregate supply (in which production bottlenecks lead to an economy-wide bidding war) or an excess of aggregate demand (in which spending growth is outpacing production). As Karl Smith says: there is no such thing as immaculate inflation.

But Davis has no theory of inflation; he just asserts that prices are rising faster than wages, and then picks out a few prices that conform to that argument. He seems to have the spooky idea that the Fed is causing inflation, but has not figured out why or how it does.

But suppose that Davis is right, and inflation is up across the board. What's his solution? He vaguely complains that the Fed's monetary policy is too loose, and that it should be reined in. However, the direct result of that would be to increase unemployment. If there is too much spending chasing too few goods, then throwing a bunch of people out of work is one way to reduce that spending. The way the Fed does this is by tightening money and making lending more difficult, thus slowing the economy. (The central bank has adopted this strategy in the past: see the Volcker Recession for a concrete example.)

Davis seems to miss this point, because he later complains that there are too few jobs and wages are too low. But winding down the Fed stimulus would curb job creation and lower wages — indeed, that's the whole point.

Now, to be clear, I'm no great fan of the Fed's current stimulus program. In fact, I've outlined a comprehensive plan to reform the Fed (swiped wholesale from Steve Randy Waldman) that would fit nicely with Davis's desire for a "gas and groceries" agenda. I doubt he would come on board, though, because I strongly suspect conservatives will automatically resist any analysis based on aggregate supply/aggregate demand as a sneaky back door to Keynesianism.

But aggregate demand isn't just a left-wing plot to get Full Communism past the guardians of the free market. On the contrary, you can't get any sort of sensible analysis without it.