Many believe that the January increase of the Consumer Price Index portends a revival of the inflation that accelerated in 2021, reached a peak in mid-2022, and followed a downward trend until very recently. The CPI, however, is simply a cost-of-living index based on a typical basket of consumer goods. It catches both the change in the general level of prices and changes in relative prices. A similar problem, due to the nature of price indexes, mars the Personal Consumption Expenditures (PCE) index. Quoting or paraphrasing an economic consultant without quotation marks about the rise in the CPI growth, a Wall Street Journal reporter echoed the general confusion between inflation and relative price changes, and about the nature of price indexes (“Inflation Heated Up in January, Freezing the Fed,” February 12, 2024, update of 9:41 am ET):
The bigger-than-expected increase in prices last month largely reflected higher prices for used cars and auto insurance, said Omair Sharif, founder of research firm Inflation Insights.
If an acceleration of inflation is really happening, it would not largely reflect the higher used car prices, it would be the other way around: these specific prices would partly reflect the higher inflation. A recorded price change is made of its relative change (relative to other prices) and the impact of inflation. (On that topic, see my post “Does a Price Decrease Fuel Deflation?” as well as my chapter “A Rising Product Price Doesn’t Cause Inflation,” in Ryan Bourne, editor, The War on Prices.)
The increase in used car prices could be simply a change in relative prices—the consequence of car buyers realizing that the American tariffs threatened or announced on automobiles manufactured in Mexico and Canada as well as on steel and aluminum will increase the price of new automobiles on the American market. An estimate of a $3,000 increase in the price of the average new car looks realistic, if not on the low side. Consequently, we would expect many buyers to shift to used cars, arbitraging the price difference between the two substitutes. Prices would start changing as soon as the tariffs are expected. The increase in car values would also lead to higher automobile insurance prices because of the higher accident costs. Such price increases would reveal no inflation in the sense of a self-sustained increase in the general price level. (On used car prices, see my 2021 post “No Mystery in the Current Used-Car Market” and my 2022 follow-up “Do Used Car Prices Vindicate Adam Smith?”)
Through inflation or relative changes, prices do change. And inflation can happen. How will the state react and what can be the consequences? Here is, under the form of a simple model, a possible scenario—until, in my last paragraph, the fog of the future becomes too opaque and the causal strands too numerous.
Imagine a country—call it “Syldavia” if you will—ruled by an ignorant bully. (My model is a wink to behavioral economics, but note that the ignorant bully still behaves rationally given his character and circumstances.) His policies cause a rise in some relative prices that are politically touchy. Unbeknownst to him and hidden by his flattering sycophants, some of his policies such as a series of high customs tariffs can also cause a supply shock, that is, a broad downward shift in the economy’s production possibility frontier. This would cause a one-time jump in the general level of prices and a fear of stagflation. The ruler will be tempted to counter the problem with an increase in the money supply by pushing down interest rates or other interventions to the same effect. (Viktor Orban, the Hungarian ruler, tried that.) Undoubtedly, this will start or increase inflation, a politically self-sustained increase in the general level of all prices.
As the incipit of Anthony de Jasay’s The State asks, “What would you do if you were the state?” How will the ruler of Syldavia reacts when inflation and economic stagnation have started? He may try to hide the inconvenient numbers by stealthily ordering the deep state’s statistical agencies to cook the books. (“I have a good intuition of what the numbers are.”) Some high-level statisticians will resign or be fired; under Mussolini, they were quite malleable. The more the chief ruler lies, the more his minions will. The real economic trends will still be reported by private economists and, as long as a free press exists, through “fake news.” Prices on financial markets won’t lie, if these markets remain more or less free.
What would do then if you were the ruler of Syldavia? You would impose some price controls, perhaps starting with prices that are visible, politically sensitive, and easier to control. Shortages will soon appear. To quell popular discontent as the situation worsens, you will likely follow up by decreeing general wage and price controls. (Richard Nixon could not resist the temptation in the early 1970s, which did not prevent the stagflation from dominating the rest of the decade.) After all, if the ruler doesn’t like a price, he only has to forbid people to quote it or to pay it, at least on legal markets. Just forbid it! The police or the army can take care of that problem (if they are not part of the corruption).
From then on, different scenarios are possible in Syldavia, a country with unlimited democracy. A very detrimental scenario, although not at the extreme of the catastrophe spectrum, is the Argentinization of Syldavia. Perhaps, in a century or so, after many Peron-like rulers, a Javier Milei will appear to restore the old-time prosperity. But perhaps not.
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“The Baby King Breaks His Subjects’ Toys,” by DALL-E inspired by your humble blogger
