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first and second round effects of external prices rises on inflation

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first and second round effects of external prices rises on inflation
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There is a major problem in discussing ‘inflation’ - the confusion of external price rises, for example a rise in world energy prices.

Price rises are not ‘inflation’.

But price rises will show up in measures claimed to reflect inflation, such as RPI or CPI indices. Thus, such indices reflect both inflation and external price rises.

Higher external commodity prices such as energy prices also have the potential to put downward pressures on living standards.

This is a useful talk by Ben Bernanke (mid-2006) discussing this problem:

“[...] economists have struggled to understand the ways that disturbances to the supply and demand balance in energy markets influence economic growth and inflation [...]”

“Compounding these difficulties in markets for crude oil have been constraints and disruptions in the refining sector of the energy industry. In the wake of Hurricane Rita, one-quarter of domestic refining capacity was offline, and here, too, the period of recovery has been protracted. Even before last year's hurricanes, however, a mismatch appeared to be emerging between the incremental supply of crude oil, which tended to be heavy and sulfurous, and the demand by refiners for light, sweet crude, which can be converted more easily into clean-burning transportation fuels. These developments have highlighted the need for additional investments in refining capacity to bridge the gap between upstream supply and final demand.”

The talk includes useful summaries of oil and gas markets.

“[...] Because the United States imports much of the oil that it consumes, an increase in oil prices is, as many economists have noted, broadly analogous to the imposition of a tax on U.S. residents, with the revenue from the tax going to oil producers abroad [...]”

Those first and second round effects:

“[...] The rise in prices paid by households for energy--for example for gasoline, heating oil, and natural gas--represent, of course, an increase in the cost of living and in price inflation. This direct effect of higher energy prices on the cost of living is sometimes called the first-round effect on inflation. In addition, higher energy costs may have indirect effects on the inflation rate--if, for example, firms pass on their increased costs of production in the form of higher consumer prices for non-energy goods or services or if workers respond to the increase in the cost of living by demanding higher nominal wages. A jump in energy costs could also increase the public's longer-term inflation expectations, a factor that would put additional upward pressure on inflation. These indirect effects of higher energy prices on the overall rate of inflation are called second-round effects.”

The overall inflation rate reflects both first-round and second-round effects. Economists and policymakers also pay attention to the so-called core inflation rate, which excludes the direct effects of increases in the prices of energy (as well as of food). By stripping out the first-round inflation effects, core inflation provides a useful indicator of the second-round effects of increases in the price of energy.

“[...] The market for alternative fuels is growing rapidly and will help to shift consumption away from petroleum-based fuels. Government can contribute to these conservation efforts by working to create a regulatory environment that encourages the growth in energy supplies in a manner that is consistent with our nation's environmental and other objectives. Given the extraordinary resilience of the U.S. economy, I am confident our nation will be up to this challenge.”

That is, substitution could work to offset pressures on fossil fuels.

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PS. Here is Bernanke’s presentation before the Joint Economic Committee of the US Congress, 8 November, 2007, mostly on the current credit crunch.

He is not the genius that Alan Greenspan is, but he looks like a good solid workman and doubtless experience will grow.

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someone will get me paranoid!!

Ron Paul went into questioning Bernanke at the Joint Economic Committee of the US Congress presentation. He did something unusual among politicians. He spoke as if he understood money.

The programme broadcast of the questioning of Bernanke inconveniently broke at that point.

Since that time I have been chasing around for a transcript, thus far without success.
I have seen Paul’s interaction referred to as ‘a rant’, all the time without real transcript of his comments.

I did find a link to a video of Paul’s questioning, but when I went to call it, I found that it had been removed!!

Persisting, I have come up with other video links from earlier Paul-Bernanke interactions:

Here are a couple of them - highly recommended:

[3:34 minutes]

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[5:37 minutes]

Note carefully Bernanke’s response in the second video.


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