Before being introduced to Austrian economics (too late, but better late than never), one just took economics ideas and concepts as given in textbooks. Macroeconomics textbooks were around two policies – fiscal policy and monetary policy. In monetary policy the main thing was inflation and in fiscal taxes and deficits. The way to measure inflation was consumer price index. A central bank’s main role was to keep inflation under control and for this CPI was the best measure. All these ideas were written in a manner which rarely made us question them.
This piece by Prof. Richard Ebeling questions the usage of CPI for monetary policy:
It is worth observing that, even if average CPI price inflation were to be kept at a rate of two percent a year, in less than twenty years, the value of the dollar will have decreased by about 50 percent. That is, the buying power of today’s CPI-measured dollar would only get you an equivalent of 50 cents worth of similar goods in less than two decades.
More fundamentally, any price index, whether the CPI or the PCE, is a statistical construction created by economists and statisticians that has very little to do with the actions and decisions of consumers and producers in the everyday affairs of market demand and supply. The price index is a false guide for central bank monetary policy.
The pricing subcategories highlight the smoke and mirrors that is the statisticians’ distinction between overall and “core” inflation. People will occasionally enter the market to purchase a new stove, couch, or bedroom set, and if the prices for these goods happen to be going down, or slowly rising, we may sense that our dollar is going further than in the past.
Factors of production and the relevant pricing of finished goods influence the choices of consumers and the decisions of entrepreneurs.
But buying goods like these is an infrequent event for virtually all of us. On the other hand, every one of us are in the marketplace paying for food, gas for our cars, paying heating and electric bills on a regular basis. The prices of these goods and services, in the specific brands and combinations that we as individuals choose to buy, are what we personally experience as a change in the cost-of-living and our personal rate of price inflation (or price deflation).
The Consumer Price Index is an artificial statistical creation, derived from thousands of individual prices, a statistical composite that only exists in the statistician’s calculations. It is the individual goods in the subcategories of goods that determine the change in the cost-of-living and the degree of price inflation (or deflation) that we each experience.
The vegetarian who is single and without children, and never buys any types of meat, has a very different type of consumer basket of goods than the meat-eating married couple that shops regularly for clothes and shoes for themselves and their growing kids.
It is the diversity of our individual preferences that determine how each of us is influenced by changes in prices, and therefore how and by what degree price inflation or price deflation may affect each of us.
By printing the CPI number every month, the government/central bank manage to hide the distortions they are making in the economy:
Today, virtually all governments and central banks inject new money into the economy through the banking system, making more loanable funds available to financial institutions, increasing their ability to lend to interested borrowers.
The new money first passes into the economy in the form of investment and other loans, distorting the demand for resources and labor used in capital projects that might not have been undertaken if not for the false investment signals generated by the monetary expansion in the financial sector of the economy. This process sets in motion the sequence of events that eventually leads to the bust that follows inflationary bubbles.
Thus, the real distortions and imbalances that are the truly destabilizing effects of monetary policy are hidden from the public’s view, by heralding every month the conceptually shallow and mostly superficial Consumer Price Index.
We clearly need to teach history of economic thought extensively and debate ideas. We have made economics way too straight jacketed over the years.