Price Index And Purchasing Power

Introduction

Measuring the dynamics of the purchasing power of the dollar in different times has always been of interest to economists. Purchasing power is a term that underlines the amount of services or goods that a certain unit of currency can buy at a certain time. Needless to say, dollar figures from different time periods have different values. While this is the case, economists have outlined that the dollar figures of different time periods have to be inflated using the dollar index so as to compare their purchasing power. The dollar index (DXY) measures the dollar’s performance against a basket of six other currencies including British pound, the Euro, Canadian dollar, Swiss franc, Japanese yen and the Swedish krona (Wickens, 2008).

However, questions emerge as to whether the dollar index would be an appropriate comparison of inflation. While there may be divergent views on the same, it is evident that the dollar index does not give a true figure about global inflation.

Scholars have come to the realization that the inverse correlation that has for a long time been accepted as existing between the gold market and the dollar index is erroneous and misleading in which case it should be abandoned (Wickens, 2008). If the dollar index goes up, the dollar would be strengthening against the six other currencies. However, what matter s is not the strength or weakness of the dollar rather it is the dollar’s value in terms of the goods and services that the consumer can buy using the dollar (Grauwe, 2012). Economists quote statistics from the Bureau of Labor Statistics of 2005. The BLS stated that about 35% percent of the average income of an American goes to housing, with transportation and food taking 16 percent and 14 percent respectively (Layton et al, 2011). It goes without saying that the cost of energy is a considerable outlay for many Americans as it carries a significant share in transportation and housing expenditures. However, looking at the dynamics of the prices of energy (electricity and gas) and food from January 2005 to 2012, it goes without saying that the dollar lost a significant value against varied daily expenditures. This is quite different from the interpretation that would be made from the functionally unchanged dollar index value in seven years (Grauwe, 2012).

In fact, this is reflected across almost every service or good. On average, the prices of food and energy have been at 45% higher than they were at the beginning of January 2005. In fact, gasoline cost double the 2005 cost. In essence, about a third of the dollar’s purchasing power was lost between 2005 and 2012, when the practical value is measured against common goods bought by average Americans (Grauwe, 2012).

Individuals who vouch for dollar index has maintained persistent strength mainly because of constant disruptions and failures in the Euro Zone, which have affected euro’s value and enhanced US treasuries as safe haven. However, countries are engaging in currency wars as they try to reduce their currency’s value so as to relieve the debt burdens, as well as enhance economic growth via export markets (Layton et al, 2011). This means that the value of currencies remains constant relative to one another, thereby clouding the devaluation in terms of spending power. This results in the dollar index remaining rigid in the range, while it has devalued against real services and goods. In essence, the nominal values that are applied to currencies become increasingly misleading and irrelevant, in which case the dollar index would be disguising inflation.

References

Wickens, M. (2008). Macroeconomic theory: A dynamic general equilibrium approach. Princeton: Princeton University Press.

Grauwe, P. (2012). Economics of Monetary Union. Oxford University Press

Layton, A. P., Robinson, T. J. C., & Tucker, I. B. (2011). Economics for today. South Melbourne, Vic: Cengage Learning.