Inflation: Make vs Buy

Posted by: Michael Mandel on August 28

Should the Fed be worried about inflation? It depends on whether Bernanke and friends are looking at the prices of what we make, or the prices of what we buy. Take a look at this chart. The blue line is the inflation rate for gross domestic purchases—that is, what we buy. The pink(?) line is the inflation rate for gross domestic product—what we make. In both cases, what’s being measured is inflation over the previous year.


Measured on a year over year basis, prices for what we make—even including food and energy—are rising at a 2% pace, their slowest rate since 2002. In fact, if we just look at this quarter, the price change for GDP was only 1.2%, the slowest rate since 1998!

On the other hand, the prices for what we buy are soaring—up 3.5% over the past year, and rising at a 4.2% rate in the second quarter.

Historically these two indexes move more or less in parallel. The last time they were so far apart was 1980, when Volcker was in the middle of executing his big squeeze. But in that case, they were both very high (roughly 11% for gross domestic purchases, and roughly 9% for gross domestic product). And they were both moving in the same direction—up.

But this time the two indexes are flashing very very different signals. So which one should the Fed look at? What we buy, or what we make?

TrackBack URL for this entry:

Reader Comments

Brandon W

August 28, 2008 01:17 PM

Again, we're comparing apples to oranges. The inflation rate using current methodology may only be in the mid-4% range. But then you compare it to an 11% rate in 1980 - which was calculated with a different methodology. If calculated using the same methodology as was used in 1980, the current CPI is 13.8%. Let's compare apples to apples.


August 28, 2008 04:51 PM

I actually asked the Fed this very question some time ago, because it looked like we were headed into this trap. I was somewhat surprised at a response that had a ring of non-form-letter to it, although it was not especially helpful. It pointed to several specific speeches, which were not revealing.

The odd thing is(could be circumstantial), shortly after there was a flurry of Fed speeches that seemed to have the following message: each nation must fight their own inflation. Perhaps it was a way of begging China to do what the Fed wishes they would, but they're not doing it, as far as I can tell.

Either way, there will be winners and losers. Reducing rates to bolster over-built housing or to help meager exports would push excessive import costs upward. Raising rates will strengthen the dollar and have the impact of reducing oil and consumer import prices, further punishing housing and banking, and making exports less competitive.

For the long-term health of the nation, I would vote for holding unchanged or lowering with a heads up to Congress and business. It seems to me that it is about time for the retail boom in unhelpful imported stuff to go bust, send a signal to China, and to get on with reducing oil imports. Who knows what motivates the Fed, though. By the way, I think that the imported energy component of food is much greater than most people realize so neither action would help the global food price situation much.


August 28, 2008 08:18 PM

Is this not exactly what you would expect from globalisation? Standard of living in "outsourcing locations" rises, outsourced production costs increase, domestic standard of living static or declining slightly (due to reduced investment in the domestic worker)- local production costs decrease.

Jim D

August 29, 2008 12:24 AM

What Brandon said.

Comparing inflation numbers in 1980 to today is completely inappropriate, and you should know better.

(But today's inflation wouldn't be 14% if measured the same way - probably more like 8.5%, at least according to the BLS. It's still not as bad as 1980. Yet.)

Mike Mandel

August 29, 2008 11:31 AM

The main point was the differential between the inflation for the stuff we make and the stuff we buy...and the resulting fall in our standard of living.

Jim--Today's inflation would not be 8.5%, by anyone's reckoning...where did you see that number?


August 29, 2008 06:35 PM


You can check here:

Accordingly to the computation of economist John Williams and his team, CPI calculated with a pre-Clinton methodology is running at 9%

We are loking at the same issue of the service inflation from a different perspective I think.
Considering that a big percentage of what we make is services (right??) they are affected by the overall squeeze on service inflation we discussed before.
The liquidity injection of the Fed is more or less mimicked by the foreign central banks (mainly Asians) and because the runaway overheated economic growth over there, the inflation is further amplified and we re-import it through our foreign purchases...but our workforce is helpless because it doesn't have bargaining power till the Asians retain relative cost-advantages in production....economists are looking at this from the wrong angle...even if we consume a little bit less because anemic income growth and credit squeeze is not going to be sufficient to counterbalance inflation...I still believe in decoupling, somewhat.
The more the Fed pumps liquidity, the more we will suffer...and let's not forget further erosion in investor's faith in the dollar which will have them running for cover even more towards commodities and other alternative assets....more increase in producer costs, more inflation...what about wiping out seniors that live on fixed income?? Yep it's nasty...
We need to tighten our belts, raise interest rates and accept a seriour recession to re-balance world trade and restore confidence in the greenback.
Asians need to do significantly more of the heavy (consumer) lifting.
Easing and currency manipulation is interfering with the natural process of re-adjusting and it will make things much worse in the end.
Ironically, if we had a "real" currency system and not a fiat one we would be already on our way to redemption...


August 29, 2008 06:39 PM


As you said, yes it is all about a fall in our standard of living....the sooner we accept this and swallow the bitter pill, the sooner we will get out at the other end, stronger.
Debasing our currency all the way to zero is not going to solve anything....

Brandon W

September 1, 2008 12:59 PM

Jim D, Michael:
My 13.8% figure comes from the same source Dominic points out, except using the 1980 methodology. According to Williams's site:

"The CPI chart on the home page reflects our estimate of inflation for today as if it were calculated the same way it was in 1990. The CPI on the Alternate Data Series tab here, reflects the CPI as if it were calculated using the methodologies in place in 1980."

Since Michael's original post stated "the last time they were so far apart was 1980", I used the 1980 methodology. Generally, that's the methodology I am prone to believe (mostly).


Mike Mandel

September 2, 2008 08:44 AM

Oh, the 1980 methodology is just wrong, and in fact would show that inflation today is negative! From the BLS website:

"Until the early 1980s, the CPI used what is called the asset price method to measure the change in the costs of owner-occupied housing. The asset price method treats the purchase of an asset, such as a house, as it does the purchase of any consumer good.'

With the price of homes falling, if we used the 1980 method, inflation would be negative.


September 2, 2008 11:21 AM


In using the early methodology, I'm pretty sure Williams calculation takes in account housing...despite of this, the "old way" CPI figure is 9%...
The work of his team is very rigorous and I know for a fact that his site and newsletter is subscribed by several big organizations in the investment world.
Michael you should visit the site, is full of technical information on how the numbers are calculated, the approach chosen, etc...
I'm sure Businessweek can pick up the subscription tab... ;-)

Jim D

September 2, 2008 01:15 PM

My 8.5% number comes from eyeballing the BLS's backtesting of their new methodology to the Carter era. Sadly, the BLS doesn't forward port their old methodology, which would probably be more useful.

The shadowstat data is completely suspect, as they use a proprietary way of computing inflation that only seems to just add a few percent to existing data. Backing out the freakish OER change would actually show lines that sharply diverge, rather than stay only slightly divergent, so I simply can't trust that number - if it looks wrong, it probably is wrong. It's up to them to prove otherwise, and they haven't.

And the 80's way of computing housing costs wasn't a simple asset price computation - it was also based, in part, on the actual price paid on mortgages - which wouldn't necessary go negative. In fact, given the change in mortgage rates, and the slow resetting of teaser rates, that numbers actually gone UP in the last two years as prices decline, since all the people who used to pay 2% are now paying 5% or more on their mortgage. One reason why that method was dropped was that it caused inflation figures to rise when the Fed increased rates. A dumb reason to drop it, but an understandable one, from a government policy perspective.

I'm getting my information from the Econbrowser blog (and more importantly, the comments therein). While I don't actually agree with all the conclusions of the economists who run that blog, I don't doubt any of their facts. I was particularly disheartened when they explained the establishment of the OER, which I outline above.

Keith G

September 2, 2008 02:26 PM

The way I see this chart is that the liquidity-crisis led the Fed to pump a lot of M2 into the pipe-line. This was at high enough levels to scare people with dollar-denominated securities to run for shelter from inflation. The best place to be when there is an inflation scare is commodities (you can not only protect yourself but you can make a lot of money if you get in early). Consequently, we have a price bubble for what we buy. I think the next thing that's going to happen will be investors selling high-priced commodities and buying low-priced securities (already happening?) once the inflation scare is over.


September 2, 2008 04:08 PM


In your earlier comment, I couldn't agree more that "our workforce is helpless". So the question is, what to do about it? Is it not the case that if China had unpegged their currency from the $US much earlier and much more completely (per Henry Paulson's desires), then we would see the same inflation in imported consumer goods and industrial components that we see as a result of the increasingly weak dollar? A reduction in the standard of living might still have resulted, but at least some domestic production could have become more competitive, and steps to strengthen the dollar (and reduce the cost of imported commodities) could then be undertaken.

In leiu of the ideal behavior of the yuan, what actions could cool all the importation? One answer is further weakening of the dollar. It has undesirable effects that you've highlighted, but there are some good effects. It tends to push up the price of imported oil, thus enabling whole new industries to wean the nation from imported oil, and it gives housing and banking a fighting chance, and it puts imported luxury so far out of reach that the toxic allure will necessarily fade. A different answer would be to impose trade restrictions, but politically that would never fly and might even push China into punishing the US by dumping debt and investments. Using the mortgage crisis as an excuse to keep the dollar weak would be more palatable to China and might give them serious food for thought. It could even make Mexico competitive and eventually lure immigrants back home. I may be overly attentive to China, but I find very little that isn't made there or isn't filled with Chinese components.

Strengthening the $US will simply return us to business as usual -- imported goods and commodities including oil will become more affordable again. How much US industry would benefit? Other than automotive and massive retail establishments which gobble energy for lighting, heating/cooling, and gas-guzzling shopping trips, I cannot find much. Retail sector wages are already among the lowest. Housing would continue to deteriorate. Industries which exploit skills and talent would continue to dump the "uncompetitive" American worker. It destroys personal retirement plans that were overly dependent upon selling a home. This too reduces the standard of living and will eventually make most people unable to afford the imported goods, but what has it accomplished for the nation's long term health and workforce vitality?

Of course a permanent weak dollar policy would be disastrous, but if the Fed and the nation can hold out long enough to actually change the status quo, then it could lead to a healthy turnaround and legitimate national strength behind a stronger dollar. If I'm to be personally hurt in the short term, I would much prefer this better outcome in the long term, though I recognize the criticality of timing and that it is a gamble either way.


September 3, 2008 04:02 PM


I agree with your logic in principle but unfortunately the USA doesn't apply its monetary policy in a vacuum.
Other countries adjust their own accordingly...
When we ease, the Asians (China in the first place) will make sure that their currency doesn't appreciate too much versus the dollar in order to support their export-led growth, lately they even relented their recent tepid anti-inflationary measures.
And their cost advantages goes beyond merely currency value (barring a highly hypothetical colossal appreciation)...the most obvious are, for example, an enormous population which "naturally" constrain wage growth, more lax environmental standards, an authoritarian government, we want to race them at the bottom on a pure cost/currency value basis??
The recent spike in oil prices, which are momentarely retreating, has not significantly dented their overall cost competitiveness.
As Michael painfully reminded us with his previous blog entry, what we really need to do is restore our working class average earning power and reduce the trade deficit...we cannot all become PhDs and we run out of easy credit and financial gimmicks to sustain our standard of living.
How we do that?? Definitely not through protectionism, trade barriers, etc...
The key is to dramatically improve our productivity through a significant overhaul of our crumbling infrastructure, investing more in alternative energy, basic research, public services, etc...
Government intervention should be highly focused on kick-starting activities where the private sector would not do the first move and/or where the investment return horizon is far in the future..we can do that with a mix of direct spending, grants and tax benefits.
Raising interest rates would attract more foreign investment and restore faith in the dollar.
The rebalancing of our GDP towards more production activities versus consumer spending will be painful at the beginning, no doubt about it...after all it was painful on the other way around too from the beginning of the 1980's on.... but it will be healthy in the long run....many more not "ousourceable" jobs or at least not easily.
Again, sending checks in the mail to be spent on imported goods doesn't solve is like pouring water in a bucket with holes at the bottom...


September 5, 2008 03:00 AM


I appreciate your granting credence to my logic. I think you are pointing out that it may be oversimplified, which I wouldn't argue.

Jumping to your point about checks in the mail not solving anything, I heartily agree. If that much money is to be expended, at least government ought to attempt to accomplish something worthwhile, rather than simply inviting further purchases of imported goods, but that was not to be. Everyone in favor of free global trade seems to have forgotten Milton Friedman's admonitions about safety nets, and the whole concept of nurturing a vital economy seems to have been abandoned all around.

You advocate costly government actions. If well thought through, I believe it could work to the nation's advantage, but I doubt that it is likely to happen, and if implemented without producing immediate results, then it could destroy re-election possibilities and disrupt continuity.

I don't even know if it is viable. The resistance to higher taxes, not to mention precarious income, is so extreme that one has to ask where the money would come from -- if the tax base or war mentality is not rearranged to provide the funds, if we are not to extend the national debt beyond imaginible ways out, then we are back to relying upon the Fed to print more money, which leads back to low interest rates, relatively high energy/commodity prices, and a weak dollar.

I don't disagree with your sentiments, I just don't have a lot of confidence that enough can be accomplished by Congress, with or without the support of an astute President. That is why I find this current confluence of circumstances exciting as a possible way out of the nation's mess, if only the Fed chooses the right course and has the resolve. It shouldn't keep Congress from taking thoughtful action. It would probably require austerity and business failures, but if business would just wake up there would be opportunity. I think it represents a small but hopeful chance, compared to the gamble of Congressional action.


September 5, 2008 10:31 AM


I could not agree more.
Lack of leadership (including business) is one of the main issues here.
No elected official (or would-be elected) is going to tell to the public that at some point we need sacrifice...and no politician has a vision beyond the next election cycle.
Short-termism mentality is the norm everywhere.
We convinced ourself that we can eliminate recessions, have permanent prosperity and enjoy a lifestyle that we cannot really afford.

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

BW Mall - Sponsored Links

Buy a link now!