Where did the Inflation Came From?

Matthew Klein at the FT asks this question in a blog post he did earlier this week. The obvious answer is ‘The Federal Reserve,’ with their stated goal to make sure that the increase in prices is always a positive number. Klein writes:

Central bankers think steady price increases are a good thing. After all, inflation makes it easier for employers to cut real labour costs and helps monetary policy boost the economy without having to lower (nominal) interest rates below zero.

As an aside, Klein is correct about the intentions of central bankers. In times of recession, pressure is generally put on all prices to fall, including wages. Keynesian inspired central banking seeks to substitute a nominal fall in wages for a real fall in wages, by increasing inflation so that prices rise. The price of goods rises faster than the rise in wages, creating a real fall in wages. This policy sounds fine on paper, but leads to many problems, as I’ve outlined in the past.

Whether or not you agree, we thought it would be interesting to look at which products explain the rise of American consumer prices since 1990. As it turns out, just as the bulk of the growth in employment can be attributed to a few sectors where productivity is either low or unmeasurable, a whopping 88 per cent of the total rise in the price level boils down to four sectors of the US economy:


The accompanying chart shows that these sectors, healthcare, housing, education, and prescription drugs have accounted for the bulk of the rise in consumer prices. Klein then goes on to list several areas in which the price level has declined over the last 25 years or so.

By contrast, thanks to astounding technological innovation, television prices have plunged at an average rate of 12 per cent each year since 1990 and computer prices have fallen more than 18 per cent per year:

Price stability in goods can’t be attributed solely to higher screen resolutions and faster chipsets, because plenty of other physical objects resisted the inflationary trend. The prices of new motor vehicles only just surpassed the highs set in the mid-1990s. “Recreational books”, as distinct from “educational books”, cost the same now as in the late 1990s. Musical instrument prices peaked in the early 1990s and have since drifted lower. Watch prices are the same now as in 1990, and that’s only because of a recent upward spike earlier this year.


Luggage — luggage! — prices have plunged about 44 per cent since the mid-1990s. The prices of “dishes and flatware” have fallen 49 per cent since the peak in 1998 and the prices of “household linens” have dropped 60 per cent from their peak in 1992:

(We suspect the emergence of Asian manufacturing and the admittance of China into the World Trade Organisation were more important to these developments than dramatic spurts of innovation, but we could be persuaded otherwise.)


Less surprisingly, “telephone and fascimile equipment” is 78 per cent cheaper than the peak in 1997, in a remarkable reversal of the previous bout of price increases:

In general, the prices of durable goods are about a third lower now than in 1990, while the prices of nondurable goods excluding commodity products (food, drinks, and fuel, which tend to rise at the same rate as the broader price level over time) and excluding prescription drugs, have also fallen, albeit not by as much. Inflation outside of healthcare and education has generally been modest, with the notable exception of a few small professional services such as tax preparation, lawyers, and funeral homes.

The sectors in which prices have exploded (healthcare, housing, education, drugs) all have one thing in common: heavy government involvement over the period of time in question. The housing bubble, Federal Student loans, and increasing healthcare regulations have taken their toll on customers in the shape of rising prices.

The areas in which prices have fallen the most, such as technology and other areas, are relatively devoid of regulation. This is how a freer economy works – increased innovation leads to more efficient production and better products, which drives prices down. This enables more and more people to consume these products, spreading the innovation to as many people as possible. It is precisely the lower prices, which central bankers fight against, which allow this to happen.

Note also the fact that the sectors in which prices have risen are all necessities. This represents the height of the failure of central planning. Regulations and middling by central banks produces inefficiency and rising costs for the consumer, while freer markets produce continued lower costs and improving products. It is really that simple.