Most experts are of the view that as the economy gains strength the Fed must step in at some stage and introduce a tighter stance in order to prevent the rate of inflation getting out of control.
Why however, should economic growth be positively associated with a general increase in the prices of goods and services?
Let us examine how prices in general could go up. The price of a good is the amount of dollars paid per unit of this good.
Therefore, with all things being equal an increase in the quantity of dollars in the economy must lead to a general increase in the prices of goods and services.
Now, when we talk about economic growth what we mean by that is an increase in the production of goods and services that people require to support their life and wellbeing.
Obviously then, for a given amount of money an increase in economic growth i.e. an increase in the amount of goods and services, must lead to a decline and not to an increase in the prices of goods and services in general. (We now have more goods for an unchanged amount of dollars).
Therefore, if what we are saying is correct, why are the yearly growth rate of the consumer price index adjusted for food and energy (the core CPI) and the lagged yearly growth rate in industrial production are moving in tandem (see chart below)?
Does the positive correlation between the growth momentum of the core CPI and the lagged growth momentum of industrial production make sense?
Why should more wealth, which raises people’s living standards, also generate bad things – such as a general increase in prices of goods and services?
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