Question

True or False? Inflation is when prices rise at a high rate.

Answer 1

Answer: true

Explanation: One factor that seems to cause baby boomers to hark back to the Carter administration is high gasoline prices. When people think of Carter-era inflation, they often connect it to those high prices and the high world price of oil starting in 1973 and increasing, with fits and starts, through the 1970s. But one increased price does not inflation make. We can’t tell anything about inflation by looking at specific prices.

It is true that when a country such as the United States is a net importer of oil, an increase in the price of oil will, all else equal, cause our real GDP to be lower than otherwise. Go back to the equation of exchange discussed earlier. With slightly lower real GDP than otherwise, the price level, and therefore inflation, is higher than otherwise. But today the United States is only a small net importer of oil and as recently as late 2019 was a slight net exporter. So an increase in the price oil simply helps domestic producers to about the same extent that it hurts domestic consumers. The net effect on real US GDP is close to zero.

There’s one caveat to the above. Any government policy that causes waste makes real GDP lower than otherwise and, therefore, causes the price level to be somewhat higher than otherwise. The wasteful policy that is one of the factors in the recent increase in gasoline prices is the federal government’s policy on ethanol, which began during the George W. Bush administration. Although I can’t go into a detailed explanation here, the federal government’s requirement that refiners use ethanol in gasoline adds 30 cents to the price per gallon. Not all of that 30 cents was added recently. But the recently increased price of waivers that allow refiners to avoid using car-destroying ethanol has accounted for some of the recent increase in gasoline prices.