Every adult American knows what causes inflation and how to stop it.
The only reason we have not yet eliminated inflation is that there is a slight disagreement among us as to how to state the problem.
Some say escalating wages make higher prices inevitable, and some say escalating prices make higher wages inescapable. Just as soon as we agree on which of these analyses is the correct one, we will be able to stop inflation in its tracks.
Interest in economic news has increased, but statistics remain boring. So, as inflation has worsened, economists and business writers have sharpened their techniques for getting us to pay attention.
In the old days, if the cost of living went up 0.2 percent, a simple statement to that effect sufficed. But when the digits began getting larger, they seemed to call for exclamation points. Something more needed to be said, to underscore the profound danger inherent in such increases.
So we began saying things like, "Prices rose 1.2 percent last month, the equivalent of 14.4 percent per year." Anybody who could multiply 12 times 12 could figure that out.
Then we refined these projections further. We began compounding the increases.
The arithmetic goes like this: Assume that a measurement stands at 100 and that in the month that follows, it will rise by 1.2 percent to stand at 101.2. Now assume that during the next month the number again increases by 1.2 percent -- not from its old base of 100, but from its new base of 101.2. The compounded measurement will read 102.4144 at the end of the second month, and if the compounding continues for a full year at the same rate, the increase will be from 100 to 115.3894, not from 100 to 114.4.
Compounding is useful, but only for numbers that continue to flow steadily in one direction. Bank interest can be compounded. Population keeps growing, heaven knows. The cost of living has risen ever since the island of Manhattan sold for $24. It is logical to think about such measurements in terms of compound growth.
However, some statistics do not follow constant growth patterns. Unemployment goes down as well as up. Money-in-circulation totals rise and fall. So do profits. Many industries are cyclical.
But when the Commerce Department announced profit figures for the final quarter of 1978, they were stated in news stories as, "up 9.7 percent -- an annual rate of 44.8 percent." Front page headlines said, "Profits Soared to 44% Rate."
The impression created was misleading. Profits did not rise to a 44 percent rate; the rate of increase in profits achieved a pace which, if sustained for a year, would have been 44.8 percent.
The fourth quarter's profits were announced on page 1, but not until the reader encountered a fleeting note on page 9 did he learn that third quarter profits had been down, not up. Attentive readers became aware that the data being compounded did not meet the basic premise for compounding, namely that increases will continue at a steady rate. Inattentive readers could be duly impressed by George Meany's comments, which implied that "profit-gouging" had occurred and that its sole cause had been the higher prices charged by unscrupulous businessmen.
Some businessmen have indeed boosted prices as much out of greed as necessity. However, experts do not agree that higher prices were the sole cause, or even the primary cause, of the increase in fourth quarter profits.
An economist at the Brookings Institution told me, "Higher sales volume had as much to do with it as anything. People were buying more than they needed because they were afraid everything would cost more later. It was the classic inflation syndrome. I didn't get as excited about those profits as you newspaper peopled did. There is already evidence of a slowdown in buying in the first quarter of '79, so I expect profits to be down, too."
An economist at the Commerce Department agreed. He told me it is commonplace to express profit figures both ways: as one-quarter results and as annually compounded figures. "Of course," he added, "if you're going to take a common sense approach to it, you can't justify compounding. From one quarter to the next, profits go down as well as up."
Ah, yes! But when profits drop 9.7 percent, will that number be compounded quarterly, monthly, daily or hourly? Will page one headlines say, "Investors Lose at 44% Rate"?