There is a tendency to treat inflation as a singular beast, one that always threatens Americans with higher prices and particular pain for those on fixed incomes.
That was the message last Tuesday from the consumer price index: Prices rose 0.6 percent overall in September, a bit steeper rise than was forecast, caused primarily by the steep rise in gasoline prices (up 7 percent in September). Over the past year, consumer prices were up 2 percent, which is, conveniently, right at the level that the Federal Reserve aims for when it sets monetary policy.
But all inflation isnt the same. Some sources of higher prices pinch working- and middle-class people particularly hard and have little or no redeeming benefit for the economy; thats the worst kind of inflation. Other sources of inflation are less painful, although hardly something to be hoped for. And a final type of inflation can actually be a good thing, given the long economic slump in which the U.S. economy has been trapped.
Bad inflation: The worst kind of inflation is driven by rising prices for the types of goods that people need to buy all the time – even when those items are more expensive. Gasoline is a prime example of this, but other examples are home gas service and heating oil, and most groceries.
When the price of gasoline or a loaf of bread rises, most Americans have to accept the increase, at least in the short run. They pay more for those products, with little choice but to commute to work and to eat breakfast, and as a consequence have less money to spend on everything else.
Adding to the pain from this bad inflation, higher energy prices are usually driven by higher prices on the global marketplace, which means that this extra spending goes abroad; when the price of gasoline rises by 25 cents, much of the extra money Americans spend goes to oil-exporting nations, not to circulate among other Americans.
In the last 12 months, gasoline has been the biggest source of bad inflation. Its price is up 6.8 percent. The price of groceries (food at home, in government-speak) is up a more reasonable 1.6 percent.
One piece of good news in the bad-inflation column is piped-gas service, the utility-provided natural gas people use to run their stoves and heat their homes. Its price is down 10.7 percent in the last year, reflecting lower natural-gas prices.
Neutral inflation: Some other sources of higher prices are not so painful for people. They arent desirable, necessarily, but neither are they something to panic over. These are products that people tend to buy relatively rarely and can exert some control over when they make a purchase. If cars, televisions or computers are too expensive, for example, they can use their old one for a few extra years.
These goods have tended to exert downward pressure on inflation in recent years, although not necessarily because of price cuts. Calculating inflation on these goods is particularly challenging because the goods are always changing. A 2012 Honda Accord is a significantly better car than a 2000 Honda Accord, while a 2012 box of corn flakes is likely identical to its 2000 vintage.
The analysts at the Bureau of Labor Statistics adjust for this fact through a process of hedonic adjustment. Essentially, they try to estimate how much increased functionality a newer version of one of these goods has and use that to adjust the price change.
So, for example, when the department says that the price of new cars and trucks rose 1 percent over the past year, as it did in September, or that the price of televisions fell 18 percent, what the department means is that those were the changes in price when adjusted for the fact that you were also getting a better car or television than you were a year ago.
Innovation is a great thing, but it also means that some of the disinflation or downward pressure on prices in the economy is coming from sources that dont mean lower prices at the store.
When New York Fed President Bill Dudley explained this phenomenon at a community event in Queens last year, he noted, Today, you can buy an iPad2 that costs the same as an iPad 1 that is twice as powerful.
Retorted one audience member: I cant eat an iPad.
Good inflation: It may be that the rent is too damn high, as New York politician Jimmy McMillan famously argued. But that may have some benefits, particularly given the place the U.S. economy finds itself in today. One of the biggest components of inflation data is owners equivalent rent of primary residence, which is how housing prices are captured in the data.
Rather than measure the price of buying a house, the inflation-measurers try to estimate what it would cost for homeowners to rent their residence. The logic is that the home purchase is in large part the purchase of an asset, whereas the equivalent rent measures what the homeowner is consuming in terms of shelter (essentially, for inflation measurement purposes, every homeowner is also his or her own landlord).
This measure has an enormous role in determining overall inflation measurements – 24 percent of the CPI. And in the last year it has shown a 2.1 percent rise. More conventional measurement of rents, those paid by renters, account for 6.4 percent of CPI and was up 2.7 percent in the last year.
A central problem afflicting the U.S. economy is that housing construction has been far below any historical norm for more than five years now.
That will not change until builders see rents rising (which is happening) and would-be homeowners start to see buying a home as a steal relative to renting the same home (which may be starting to happen).
For both of those trends, higher owner-equivalent rents help speed the process along, so higher levels of inflation may get the economy closer to happier days.