Inflationary Noise

Readers Question: What is meant by the term inflationary noise ?

Definition of Inflationary noise.  When inflation distorts price signals.

If inflation is 0%, and Peugeot cars increase in price then this is a signal Peugeot are more expensive. However, if inflation is 5 or 6%, it is harder to work out whether the increased price of Peugeot cars is due to inflation or an increase in the relative price.

Inflationary noise is more of a problem when inflation is unexpected. e.g. if inflation is always 2% and this is what people expect, it is easier to work out relative prices. However, if inflation is unexpectedly high, it becomes more difficult to work out relative price changes.

Deflation would also make it difficult to work out relative prices.

By on November 14th, 2008