Inflation: what it is, and why it is not a price rise

For the members of the Financial Market Club, FSJES

Last month the price of your coffee went up. That is a price rise. It is not inflation.

Mishkin defines the inflation rate as the growth rate of the aggregate price level, which is a measure of average prices across the whole economy. His book also describes inflation as a continuing increase in that price level. Two words matter here: average and continuing. One price can jump for a reason that has nothing to do with the others, and a single jump is over once it has happened.

Al Maliya shows the gap clearly. By the end of April 2016, oil had risen 32.4% since December 2015, to 46.7 dollars a barrel. Over the first quarter of 2016, Morocco's consumer price index rose only 1%, against 1.5% a year earlier. Food prices rose 1.5% and other products 0.6%. One price moved a lot while the aggregate basket barely moved.

How the average is measured#

Statisticians build a price index. Mishkin gives three common ones:

  • The GDP deflator divides nominal GDP by real GDP. If it moves from 111 to 113, inflation is (113 - 111) / 111, or 1.8%.
  • The PCE deflator does the same for consumer spending.
  • The consumer price index (CPI) prices a basket of goods bought by a typical household. If the basket costs 500 at the start of the year and 600 at the end, the CPI has risen 20%.

Nominal and real values also come from this. If your income doubles and all prices double, your real income is unchanged. Mishkin uses this exact example.

In Morocco, the Haut-Commissariat au Plan (HCP) computes the official Indice des Prix a la Consommation (IPC), tracking consumer spending across Moroccan urban centres. Bank Al-Maghrib computes underlying inflation (inflation sous-jacente) by stripping out volatile fresh food items and state-administered tariff goods to isolate persistent monetary trends.

Demand-pull and cost-push dynamics#

Mishkin distinguishes between two fundamental transmission mechanisms that drive aggregate price level shifts:

  • Demand-pull inflation: Occurs when aggregate spending outpaces aggregate productive capacity. When consumer credit and business investment accelerate rapidly, excess aggregate demand bids up prices across multiple economic sectors simultaneously.
  • Cost-push inflation: Occurs when an abrupt supply shock raises input costs, shifting aggregate supply inward. The historical oil shocks and contemporary supply-chain bottlenecks illustrate how import-dependent economies absorb foreign cost increases that temporarily compress real national output.

Why people worry about it#

Money is a store of value, and its value depends on the price level. If all prices double, money has lost half its purchasing power. At the extreme, Mishkin describes the German hyperinflation after the First World War: by 1923, prices were more than 30 billion times their level two years earlier. Mishkin notes a positive link between inflation and money growth across countries, and quotes Milton Friedman's view that inflation is always and everywhere a monetary phenomenon.

In Morocco, Bank Al-Maghrib guards price stability with an explicit inflation-targeting approach, using reserve requirements and its key policy rate (taux directeur) to anchor medium-term inflation expectations near 2%.

For discussion#

  1. Over the first four months of 2016, world prices for sugar and rice rose on average while world wheat prices fell. Could a country have rising prices for some goods and zero headline inflation? Under what condition?
  2. If the CPI basket is built around a typical urban household in Casablanca or Rabat, which Moroccan households might the CPI describe badly?
  3. When global energy prices spike, why does Bank Al-Maghrib look at core inflation (inflation sous-jacente) rather than headline CPI when adjusting the policy rate?

For the members of the Financial Market Club, FSJES. Moroccan figures describe 2015 and early 2016, so check current numbers before citing them.

Sources: Mishkin, The Economics of Money, Banking, and Financial Markets, 7th ed., chapters 1 and 4 (inflation, price indexes, real and nominal values). Al Maliya n°60, June 2016, section "Reperes" (inflation, oil and food prices, first quarter of 2016). Haut-Commissariat au Plan and Bank Al-Maghrib official methodology notes.