Inflation vs. the Price Level, Part 1

It's essential to understand a) the difference, and b) who can do what about each.

An interesting exchange occurred during Federal Reserve Chair Jerome Powell’s press conference last week. As I’ve been discussing in numerous posts here, Powell repeatedly pointed out that the hard data—GDP, spending, jobs, real wage growth—looked good while the soft data—surveys on consumer/business confidence, expansion/investment plans—looked bad. Kelly O’Grady from CBS news countered that to a lot of people, “the hard data they’re looking at is their grocery bill,” and they don’t think it looks so great.

Powell responded, as he has in the past, and as I did regularly as a White House spokesperson on this issue of consumer costs, by distinguishing between inflation—the change in prices—and costs, the level of prices.

“…the grocery bill is about past inflation, really. There was inflation in '21, two, and three, and prices went up. The current level, it's not the change in prices, it's they're unhappy, and they're not wrong to be unhappy, that prices went up quite a bit and they're paying a lot for those things…We have, you know, 4.1 percent unemployment, we've got 2 percent growth, and you know, it's a pretty good economy. But, people are unhappy because of the price level. And I do, we completely understand and accept that.”

He’s right about this, and a picture is worth a lot of words in clarifying the issue. Given that potato chips aren’t only delicious but are also a poster child for this rates v. levels confusion, let’s use them for this. Below, I’ve plotted their quarterly dollar price per 16 oz bag since 2014. (Also, it’s about time I wrote something about chips that aren’t in computers, unless you’ve been munching them around your keyboard.)

According the BLS, they wiggled around $4.50 for many years before the pandemic price shock, at which point they jumped to $5 and then $6.50, where they’ve been since.

Now, let’s look at their inflation, i.e., the change in their prices. Clearly, between 2014-19, their price level and therefore their price change was flat. Inflation was about 0% over these years. From 2019Q4 to 2024Q4, however, their price rose 42% cumulatively, or 7% per year.

Now, here comes the kicker, and the key fact that distinguishes the Fed from your snack-demanding household (clarifying for the record, I have eaten chips over lunch with Fed officials; they like them too). Over the past year, potato-chip inflation has been 0%. If you’re the Fed, whose mission in this space is to return to stable prices (along with their full employment mandate but that’s not the focus here), that’s precisely what you want to see.

As a White House economist, based on this data pattern, which prevailed for many groceries (not eggs), I would get in front of the cameras and say, “we know prices are still too high, and we’re doing all we can to help with that. But inflation has come way down.”

Suffice it say, that people didn’t believe the first part and took little solace from the second part.

We thought a lot about this at CEA, developing theories about PPVs (personal price vectors; that list of individually-specific price-level expectations we all keep in our head; see here for a deeper dive on this and many related matters), wherein lower inflation actually mattered a lot for people. Stable prices enable us to eventually reset our PPVs, but that takes time.

But tomorrow, in part 2 of this post, I want to get into a particularly timely and important question about the price-level question, relating to the part of my TV statement above: “we’re doing all we can to lower prices.” That was true, but it begs the question: in a capitalist economy, what can the government do to lower prices?

For many, the answer is nothing, but that’s wrong. The answer invokes important work by Annie Lowry on the affordability crisis, the (deservedly!) “it” book of the moment, Abundance by Klein/Thompson, competition policy, climate policy, health care policy, and much more.

I want to be careful not to oversell this point. “Nothing” is the wrong answer to the question, but so is “a lot.” And it’s also the case that private-sector price signals are extremely important and policy makers need to be very careful about jamming them.

When it comes to inflation rates versus price levels, the Fed must stick to its inflation knitting, just as Powell said. But that’s not the case for the rest of the government.

Stay tuned…