Beware inflation misinterpretation

When I first studied economics teachers always put a lot of focus in distinguishing between inflation (which is a persistent rise in the general level of prices) and one time shocks, which actually were changes in relative prices. Now, the problem is that all the indexes that have been created to measure inflation actually mix these effects, and therefore when there are “automatic inflation adjustments” a one time change in a specific price translates to the whole economy.

On that background the whole discussion on inflation arising from the increase in price of oil and food is an overreaction: If the price of oil is a bubble it should flop and not lead to further problems. (Actually it’s interesting to observe that the high prices we have seen in the last weeks have occurred in the context of low transaction amounts, according to Thomson Reuters).

But if there’s a case for it (i.e. growth in real demand from Asia in the context of fixed supply capacity), then the economies should adjust to the new relative prices (not a new level of prices). Such is the reality of globalisation. The real danger of inflation, in my perception, lies in calling this phenomena “inflation”, since it gives a backup to wages adjusting that will generate real inflation (and bust some companies that can’t follow them) in a spiral effect that usually becomes hard to handle.

UPDATE: One week after writing this piece for my MBA I read this comment from Mankiw's blog that reinforces the idea.

Source: Thomson Reuters