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Why you should stop worrying and learn to love inflation

Published: Wednesday, Sept. 18 2013 9:35 a.m. MDT

In this March 21, 1996 file photo, stacks of $100 bills await the printing of their serial numbers, at the Bureau of Engraving and Printing in Washington.

Doug Mills, Associated Press

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Matt Towery and his wife were recently grocery shopping in Atlanta and noticed that prices seemed higher.

"My money was just not getting anywhere near what it was 2 or 3 years ago," he recalls.

For example, Towery, a conservative syndicated columnist, noticed in June of 2003 that a pound of ground chuck beef sold for $2.23. This year it goes for $3.40. Kiplinger's Personal Finance magazine predicts that grocery prices will go up 4 percent this year.

Yet, according to the government's Consumer Price Index, compared to a year ago, all prices are only up 2 percent. If you take out gas and food prices (which are more volatile in their price fluctuations), core inflation is only up 1.7 percent.

Others worry that as the economy continues to rebound, inflation will rise. But experts are divided over whether that would be a bad thing. Some economists say a certain amount of inflation is a good thing.

"There is no inflation problem in the U.S. today," Merrill Lynch's Ethan Harris told Bloomberg. "It sounds kind of crazy, but we are actually too low on inflation."

Although there were double-digit inflation spikes in the 1970s, from 1982 to 2012 the average yearly increase in the price of consumer goods has been 2.9 percent.

"We keep being told that inflation is low," Towery says. "The flip side of that is there are no substantial increases in wages or your ability to receive a good return for a stable investment."

Demand and supply

Economists tend to think of inflation in two different ways.

One is "demand side" where people are spending more money, which drives up prices. "That is what causes extreme inflation that you may read about happening in other countries," says Scott Sumner, an economist who teaches at Bentley University in Waltham, Massachusetts.

The other type of inflation is "supply side." If something happens to reduce the supply of goods to the economy — such as a natural disaster or an oil embargo — that will tend to raise prices and reduce living standards.

"Supply side inflation is the only type of inflation that hurts consumers as a group," Sumner says.

A closed system

Inflation can rise due to a shrink in supply. A drought, for example, can decrease the amount of wheat. The demand stays the same, however, and the price in bread goes up. Food items are one area that are particularly sensitive to this type of supply variance.

But aside from sudden and unpredictable drops in the supply, inflation normally will raise not just prices, but also incomes. People may be paying more for items, but the people selling the items are also earning more revenue.

"If you think of the economy as a closed system," Sumner says, "then inflation doesn't hurt people in and of itself. Every extra dollar spent is someone else receiving an extra dollar. When most people think about inflation, the mistake they make is they forget that inflation pushes up their own incomes."

If the inflation rate is reduced to a lower level, that would also reduce the rate at which wages and salaries are rising by the same amount. "So it wouldn't really help the public in the way they think," Sumner says. "They are likely to think the salary they get is somehow separate from the question of how fast prices are rising. They don't see the connection. So they look of inflation as a bad thing."

For example, Sumner remembers when gas was 32 cents a gallon.

But he also remembers when the minimum wage was $1.25 an hour. "Everything was lower," he says. "It raises the question of whether inflation matters at all."

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