One of the more common responses to the fact that inflation is low is the idea that the inflation is all in asset prices. So, for instance, if someone were to say that all the Fed’s post-crisis stimulus didn’t result in inflation you might look at stock prices and argue that the price increases all flowed into stocks. That’s not necessarily wrong, but I think it needs to be well understood because asset price inflation is generally good for the economy while consumer price inflation could be bad.1
First off, we should start with clear definitions – consumer price inflation is a general rise in the price level. Importantly, when individual prices rise, such as gas prices, it does not mean there is “inflation”. It means gas prices rose. But “inflation” measures the entire basket of goods. We’re trying to understand aggregate prices instead of a component of the aggregate. So next time you drive by your local gas station and raise a fist at the rising prices don’t be tricked into thinking that that means inflation is higher since it could very well be offset by price declines elsewhere.
Consumer price inflation is constructed to measure the price of things we consume. So, for instance, if I need to drink water and it costs $1 per gallon this year then a 10% increase in the price of water could negatively impact my standard of living because the water is something I consume. The water goes away when I consume it and I can only maintain my standard of living by consuming more of it.2 If I have to work the same amount to consume more expensive water then I am worse off than I previously was.
Asset price inflation is different. When asset prices rise we are generally better off than we were before. For instance, when the price of the S&P 500 rises by 10% we are that much wealthier than we were before because now we can sell something we saved for a higher value than we originally purchased it at.3