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June 12, 2021, 11:27 a.m. EDT

Here’s why higher prices for car rentals, airfares and blouses won’t lead to higher inflation

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By Rex Nutting

The first ironclad rule of economics is that nobody likes paying higher prices. So it’s no wonder that people are getting nervous when the prices of some goods and services surge as the global economy emerges from the COVID-19 disruptions.

In May, the U.S. consumer price index rose 0.6% and grew 5% over the previous 12 months, the fastest rate in 13 years. That sounds ominous, doesn’t it?

Breaking news: Consumer prices soar again, CPI shows, and shove rate of inflation to a 13-year high

But a closer look at which prices rose and which didn’t provides some comfort: Prices are mostly reacting to huge disruptions in supply and demand in particular markets, not to a general inflationary dynamic in most markets.

Does anyone really believe that the prices of used cars — which have been flat for 20 years — will keep rising 7% every month from now on? Or that computer prices — which have fallen 90% since the late 1990s—are suddenly an inflationary hotspot? Of course not! The recent price increases will not persist once the supply-chain issues are resolved, which will likely take months, not years.

Higher inflation rates aren’t baked into the cake. Not yet. Most likely, annual inflation will moderate back to the 1.5% to 2.5% range that has been normal for years.

Relative price changes are not inflation

It may sound odd, but higher relative prices are not inflation per se. If the prices of used cars or computers or tickets to Saturday’s ballgame jumped because the demand rose faster than the supply, that’s not inflation. It’s just a relative price change, the kind of thing that happens continuously in dynamic market economies.

Menzie Chinn: Here’s how to tell if this spurt of inflation is here to stay

The second ironclad rule of economics is that prices matter a lot in a market economy.

Relative price changes are the main signal that buyers and sellers alike use to guide their economic behavior. If prices for vehicles, computers and many other durable goods are higher because semiconductors are in short supply, that sends a powerful signal to sellers to produce more chips, or to find alternative sources, or to find cheaper substitutes. They tell buyers to hold off buying if they can, or to find cheaper substitutes.

Or, if prices are lower because people aren’t leaving their homes due to health precautions, that’s a powerful signal to sellers to produce fewer full-service restaurant meals, baseball tickets and hair cuts, and to produce more takeout food, streaming entertainment content and do-it-yourself hair clippers.

With the help of price signals, supply and demand in those particular markets can quickly come to a new equilibrium.

Essential role of prices in market economy

It’s no exaggeration to say that prices are the essential mechanism that makes the market economy work. They are the market. Prices ebb and flow all the time in particular markets without stoking inflation or deflation in all markets. Policy makers notice these changing prices, but they don’t intervene unless they become so general and persistent that buyers and sellers begin to be guided by their expectations of future inflation (or deflation) in all markets instead of by conditions in their own market.

Harold James: Higher prices aren’t always a bad thing. Sometimes they nudge producers and consumers toward necessary changes

When we think about inflation or deflation, what we really want to know is what will happen to our purchasing power. Will our income be sufficient to purchase the same or a better standard of living next year or in 20 years? Will we be able to repay our debts? Will our investments appreciate faster than prices?

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