Inflation For Dummies Part 2

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A few weeks ago, I wrote Inflation For Dummies.  Apparently that was too complicated for a lot of people.  So I’m writing a simplified version: inflation for dummies part 2.

Here’s the deal.  As long as there is inflation (inflation rate greater than zero) the average price level will continue to rise. The only question is, “How fast?” The average price level can only fall if there is deflation (inflation rate less than zero).  When the inflation rate is still positive, but falling, we call that disinflation.

If the phrase “average price level” is confusing, use “prices” instead.  But remember, inflation is not an increase in the price of any product or group of products.

An Example

Consider the U.S. economy since 2020. Specifically, let’s look at the Consumer Price Index (CPI).  Here’s the data:

CPI (Price Level) Inflation for Dummies Part 2

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And here’s the inflation rate (measured month-to-month at annual rates):

Inflation Inflation for Dummies Part 2

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There’s one specific period I want to focus on: January through May, 2020. During that period there was deflation, as shown in the next chart.  The circled area is where the inflation rate was less than zero.  The green horizontal line is 0.00% inflation. The average price level does not change when inflation is zero.

Inflation marked up Inflation for Dummies Part 2

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Since there was deflation, the price level should have fallen.  Let’s take a look.

CPI (Price Level) marked up Inflation for Dummies Part 2

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Sure enough, prices were falling. The CPI continued to fall until June when the inflation rate turned positive.

Conclusion

Pundits of all shapes, sizes, political leanings, and stripes constantly confuse inflation with the price level.  Please stop.  This is not difficult.

As always, my methods are transparent.  Click here to download my Excel workbook.

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About Tony Lima

Retired after teaching economics at California State Univ., East Bay (Hayward, CA). Ph.D., economics, Stanford. Also taught MBA finance at the California University of Management and Technology. Occasionally take on a consulting project if it's interesting. Other interests include wine and technology.