This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux
At the heart of some of the most contentious debates in the otherwise drab world of macroeconomic theory is that of inflation (yes, there are in fact contentious debates about macroeconomic theory). To wit, economics can’t even agree on a definition for the term.
The laymen understanding of inflation is the rising of prices. Some economists agree, while another camp argues that higher prices are merely one of many signs of inflation, which they define as an increase in the supply of money within an economy.
Commonly, inflation is measured by the Consumer Price Index, or CPI, which purports to be a representative basket of goods and services that reflects what the average consumer buys with his or her hard-earned dollars. And while there are myriad criticism of the CPI and how government bean counters arrive at the final tally, that is a debate for another forum.
Suffice to say, as can be clearly seen below, prices in the US have been steadily rising for about as long as anyone can remember. And as some generations remember better than others, during the 1970s and 1980s, prices rose rapidly indeed.
Most credit then-Federal Reserve Chairman Paul Volcker (currently the chairman of President Obama’s Economic Recovery Advisory Board) for breaking the back of inflation in the early 1980s with a hard-line policy of high interest rates. High borrowing rates discourage investment, curtailing economic growth, which can slow the pace of rising prices. This politically unpopular monetary policy led to persistently high unemployment and a deep recession, but ultimately inflation was brought under control.
Since Volcker’s tenure as Chairman, successive Fed Chairmen have kept interest rates low, while presiding over a period of slowly rising prices. While this sounds like a perfectly healthy economic balance, many argue this “balance” fostered the eventual imbalances that threw the global financial system into such wild disarray.