Skeptics of the Federal Reserve's intervention have already begun raising their voices about inflation. They point to commodities, as food and energy prices have soared in recent months. Is it time for the Fed to clamp down and prevent additional inflation? Not if these relative price changes are just that -- relative price changes due to normal growth. If they aren't caused by additional money creation, should the Fed attempt to reduce prices by cutting the money supply?
Food and energy prices are generally volatile, which is why they are excluded by the Fed when it considers inflation. This decision causes some controversy. Some people sarcastically remark, "Well yeah, there's no inflation unless you eat or drive a car." But it seems sensible to exclude these factors if they swing upwards due to a temporary economic shock only to fall downwards when the shock subsides.
On Friday, however, I wrote a post arguing that food and energy prices can result in a more general rise in prices if they are the result of permanent supply or demand shifts. So in cases where food and energy price shifts appear permanent, economists might want to take them more seriously.
University of Oregon economist Mark Thoma commented on the post, saying that this assertion confuses relative prices with pure inflation. He wrote:
A rise in the price of food and energy due to rising demand relative to supply changes relative prices, and increases the cost of living, but it is not technically inflation.
I followed up with Thoma, and he expanded on the point. He said that if the prices of certain goods are rising due to normal growth, then there's little reason to try to change them, as this accurately reflects scarcity in the market. But if excessive money growth is causing prices to change, then the Fed can step in to curb the inflation.