Inflation, Rates of Change, and Prices

The price of something is how much it costs in absolute dollars and cents. A burrito at the shop near me is $7.99. That’s the price.

The rate of change is how much the price changes. A RoC of 10%/yr means that next year, the burrito would cost $8.789, which would probably get rounded to $8.79*. This is the rate of change.

If the rate of change is 10%/yr one year and 0%/yr the next year, the prices went up and DID NOT GO BACK DOWN. So the burrito in year 2 is $8.79 (and going forward, I’ll just assume this gets rounded). Even if several years of 0%/yr RoC pass, the price of the burrito remains $8.79. For the price to go down, the RoC would need to be negative, and to go back to where it was, it would need to be -9%. It’s going down from a bigger number than it went up from, so -9% and +10% are offsetting, within the limits of rounding.

Inflation is a rate of change.

So if

A) transitory inflation occurs, prices go up. Even if inflation, the RoC goes down, the prices don’t go down unless inflation goes negative. Negative inflation is called deflation**.

B) permanent/nontransitory inflation occurs, prices go up continuously every year.

As human beings we care more about prices than RoC (inflation), because the price is the number we have to pay. Economists and policy makers tend to think more about RoCs. This isn’t malicious. The Fed isn’t buying eighty million burritos, and my corner burrito joint isn’t selling eighty million burritos. But the Fed is looking at price trends across the US and world, and the most useful way of doing that leans heavily on RoCs.

We can argue about ‘most useful’ so if that term doesn’t work for you, substitute with ‘most popular right now’.

Lumber prices recently spiked and came back down. They’re still about double what they were two years ago, though half what they crested at. That doubling, ~50% inflation, isn’t going away. For the immediate future, it’s permanent.

Car prices, new and used, housing, and so forth all climbed significantly. The RoC, inflation, seems to have dropped, but the prices haven’t dropped. The prices just aren’t going up as much as they used to.

If prices drop, we generally call the temporary peak a bubble. That’s not really a good term, because the temporary peak could be due to supply constraints or demand spikes, and bubbles are generally associated with speculative excesses. Price movements due to underlying factors unrelated to whether a buyer is buying only to sell to someone else later are sometimes aren’t proper bubbles. But if prices go up and down, people will call it a bubble regardless of underlying reason. People do things for multiple reasons. You can live in a house, get mail there, and also sell it later. Which is most important? Depends on the person.

Anyway, we now have some inflation, the Fed is claiming it’s transitory, but parsing that statement, understand the simple fact that prices have gone up and without deflation, they’re not going back down.

*Yes, it would actually get rounded to $8.99, but I’m trying to keep the math simple.

**Deflation is one of those things that’s good if it’s happening to you and bad if it’s happening to other people. Think of it like cutting in line. If YOU can cut in line, that feels great! If other people can cut in front of you in line, that’s an injustice.

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