July 29th, 2019
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If you enjoy this article, see the other most popular articles
If you enjoy this article, see the other most popular articles
Inflation in the USA has been low, the increase in asset prices is not a form of inflation because you don’t lose the money you spend
(written by lawrence krubner, however indented passages are often quotes). You can contact lawrence at: firstname.lastname@example.org, or follow me on Twitter.
I was engaged in a very disappointing conversation on Hacker News, where most people don’t seem to understand even basic economic facts.
Inflation is low, so the Fed should consider cutting rates. Lower rates means lower unemployment, which should eventually lead to higher wages. As a model for what the Fed rate should be, assume that it should always be 0% plus whatever amount is needed to limit inflation. Since inflation has been low and stable, the rate should remain close to 0%. After all, we should want a world where unemployment goes low enough that wages eventually go up. And, it is important to notice, in today’s world, even an unemployment rate of 3.6% has not been low enough to cause the kinds of wage gains that were normal for most of the 20th Century. If wages aren’t rising and if inflation is low, then the Fed should be pushing the rate back toward 0%. The lower the rate, the easier it is for entrepreneurs to get money, to build a business, and thus to stimulate economic activity, and if enough entrepreneurs do so, then presumably unemployment will eventually go down to whatever level is needed to raise wages.
In this chart you’ll see that the last 10 years have seen the lowest average inflation that the USA has enjoyed since the 1950s:
I posted this information as a comment on Hacker News and someone responded:
Inflation isn’t extremely low. The last 2 years was 2.4% and 2.1%
It’s the lowest rate for any expansion since the 1950s, so “extremely low” is justified, unless you want to go back to a century ago. It is high inflation compared to the Great Depression, but if the Great Depression is your utopia, you will end up with a very skewed version of the economy.
Someone else wrote:
Housing prices have doubled in the past decade. Home ownership has declined in the past decade. Seems like inflation to me.
If you buy a house, then you still have all the money that you had before you bought the house, so this doesn’t count toward inflation. If you have $500,000 and you buy a house for $500,000, you have not lost any money. You now have an asset worth $500,000. You could sell the house tomorrow, and get $500,000 back in cash. Assets don’t count toward inflation, because you don’t lose any money. Just the opposite, most people make money on their homes. You buy a house for $500,000 and then a few years later you sell it for $700,000 — you’ve made money! Consumer inflation tracks consumables, such as bread, eggs, dish washing machines, books, paper towels, televisions — things that get consumed and then need to be bought again.
If you want to see how housing costs are contributing to inflation, then the nearest equivalent is rent, which is calculated as part of the CPI. “rayiner” helpfully posted this information:
Median rents went up by 30% between 2007 and 2017: That’s 2.6% per year, somewhat higher than the 2% inflation target, but not much.
Also, about this:
Home ownership has declined in the past decade.
Is that because of inflation or because of stagnating wages? If inflation was 50% a year, and wages were going up 60% a year, then we would expect that more and more people would be able to afford a home. The happy moment when the ratio of wages to rent peaked was in the year 1958, when people were only paying an average of 22% of their wages on rent. During the post war boom of 1945 to 1958 inflation was rising, but wages were rising faster. We got to that happy moment in 1958 not because inflation was docile but because wages were rising aggressively. (And 1958 was the peak year of the Baby Boom, for the obvious reason that it was the year when people could most easily afford a place to live.)
Brett Levin writes:
A monetary supply inflation measure like M1 shows a remarkable rise since 2008. The central bank added lots of money by financing the US government debt, and that has indirectly bid up financial assets, VC, etc. If you owned US financial assets over the last decade you are flush; if you didn’t you are wondering why important things in life are so expensive.
The last decade taught us that large increases in the money supply does not necessarily lead to price inflation. Oh wait, that isn’t true, it was actually the experience of Japan, in the 1990s, that taught us this lesson. The first person to understand this was Paul Krugman. Way back in 1998, Krugman wrote “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap“. At the time, the liquidity trap seemed like something obsolete, something that belonged the pre-war era, something that we’d left behind in the 1930s. If you want to understand our current era, then you have to understand what Krugman wrote:
THE LIQUIDITY TRAP-that awkward condition in which monetary policy loses its grip because the nominal interest rate is essentially zero, in which the quantity of money becomes irrelevant because money and bonds are essentially perfect substitutes-played a central role in the early years of macroeconomics as a discipline. John Hicks, in introducing both the IS-LM model and the liquidity trap, identified the assumption that monetary policy is ineffective, rather than the assumed downward inflexibility of prices, as the central difference between Mr. Keynes and the classics. ‘ It has often been pointed out that the Alice in Wonderland character of early Keynesianism-with its paradoxes of thrift, widows’ cruses, and so on-depended on the explicit or implicit assumption of an accommodative monetary policy; it has less often been pointed out that in the late 1930s and early 1940s it seemed quite natural to assume that money was irrelevant at the margin. After all, at the end of the 1930s interest rates were hard up against the zero constraint; the average rate on U.S. Treasury bills during 1940 was 0.014 percent.
Since then, however, the liquidity trap has steadily receded both as a memory and as a subject of economic research. In part, this is because in the generally inflationary decades after World War II nominal interest rates have stayed comfortably above zero, and therefore central banks have no longer found themselves “pushing on a string.” Also, the experience of the 1930s itself has been reinterpreted, most notably by Milton Friedman and Anna Schwartz.2 Emphasizing broad aggregates rather than interest rates or the monetary base, Friedman and Schwartz argue, in effect, that the Depression was caused by monetary contraction; that the Federal Reserve could have prevented it; and implicitly, that even the great slump could have been reversed by sufficiently aggressive monetary expansion. To the extent that modern macroeconomists think about liquidity traps at all (the on-line database EconLit lists only twenty-one papers with that phrase in title, subject, or abstract since 1975), their view is basically that a liquidity trap cannot happen, did not happen, and will not happen again.
But it has happened, and to the world’s second-largest economy. Over the past several years, Japanese money market rates have been consistently below 1 percent, and the Bank of Japan plausibly claims that it can do no more; yet the Japanese economy, which has been
stagnant since 1991, is sliding deeper into recession. Since Japan is such an important economy, and its slump threatens to shatter the already fragile prospects for economic recovery in the rest of Asia, understanding what is going wrong there has become quite urgent. And there is also a deeper reason for concern: if this can happen to Japan, perhaps it can happen elsewhere.
To his endless credit, Krugman was painfully correct when he wrote “perhaps it can happen elsewhere”. Just 10 years later, in 2008, the problems seen in Japan were to spread all over the global economy. The whole world ended up in a liquidity trap, with rates pinned near zero.
“Lower rates means lower unemployment, which should eventually lead to higher wages”
You’re talking about the Phillips curve (https://en.wikipedia.org/wiki/Phillips_curve). I wonder if it’s not dead. We’ve got the lowest unemployment rate in decades but no very little increase in AHE (average hourly earnings). It seems like while a lot of people are competing for jobs, companies still aren’t willing to pay more.
Not exactly. The assertion that more demand for labor should raise the price of labor is a simple assertion of supply and demand. If unemployment is low, but wages aren’t rising, that means there is only demand for labor if the labor is cheap, which is just another way of saying that demand for labor is still weak.
In the USA, median wages for males peaked in 1973, and family income peaked in 1999 (thanks to women working, family income increased even when male wages were in decline). The point is, the USA economy has been weak since the end of the 1990s, and its been especially weak since 2008, and what would help get it back to full strength would be sending a large amount of cash to every American (fiscal stimulus). Or the government could launch into an ambitious program of rebuilding the nations infrastructure, increasing the budget deficit and this allowing more fiscal stimulus. But the Republicans have opposed all forms of fiscal stimulus, so instead of fiscal stimulus, we have to rely on monetary stimulus to get the economy going again. Monetary stimulus isn’t as effective as fiscal stimulus would be, but it is the best we can do in the face of Republican opposition. And monetary policy has returned the economy to something that resembles normal, albeit a weak version of normal. The fact that wages are not rising faster suggests that the economy still has a lot of slack, and we will need a lot more stimulus before we get back to full strength.
Consumer price inflation is low. Given the scale of money creation, it is likely that ‘real’ non-consumer prices are not completely real and are actually experiencing inflation, but for some reason the people claiming the money are competing for financial assets rather than consumer resources.
Okay, so let’s think about this. In some eras new money goes to consumers, and in other eras new money goes to asset owners. And what is the difference between those two eras? The eras when new money goes to consumers tend to be eras when labor unions are strong. During the post war boom if the nominal money in circulation went up 6% and productivity when up 4% then we often saw a division where wages went up 4% and inflation was 2% (nominal wages would go up 6%, real wages would go up 4%). Actually, for a long stretch, when labor unions were strong, if productivity went up 4% then real wages went up 5%, which is to say that the percent of national income that went to labor increased, whereas the share of national income that went to capital decreased. In Belgium they had 30 straight years when labor got 110% of all productivity gains. But things have changed. Since the conservative ascendency in the 1980s, the rise of President Reagan in the USA and Margaret Thatcher in Britain, labor has been losing its share of national income, whereas capital has been regaining the share of national income that it enjoyed a century ago. And since the crisis in 2008, the wealthy have gained 125% of all productivity gains. If we’d like to get back to the era when new money shows up at as higher wages, perhaps we should fight for stronger labor unions, as they are proven to help raise wages. Or the government could simply put a check in the mail and send money to every citizen. If this was paid for via debt, it would count as fiscal stimulus; if it is paid for by taxes, then whether this helps labor or capital depends on who pays the tax. If it is paid via a regressive tax such as a sales tax, then it would be regressive, but if it was paid for via a tax on capital gains, then it would help shift national income away from capital and toward labor. This notion of sending cash to every citizen is a little bit like the idea of Universal Basic Income, but this could be done as a one time payout, rather than an ongoing program. One of the goals of such an action would be to drive down unemployment low enough that wages start to rise.
In the 1960s the median house cost 2 times the median income, in 2018, the median house cost 9 times the median income. My parents bought their house in 1964 for $20,000, it is now valued at $300,000, but nobody would care about the 1,500% increase in the price if wages had gone up 2,000%.
For those with the time, wanting some history on the rise of inflation and debt (and many other things) I suggest that you read Fernand Braudel. He talks a bit about the emergence of debt in the 1200s and the “price revolution” of the 1500s, and the regularization of an economy that depends on debt and inflation. The important point is that we’ve been depending on debt and inflation for at least 500 years now. During that time, we’ve seen eras when the lower and middle classes were strong, and other eras when the lower and middle classes were weak. It’s clearly not the inflation or debt that causes the problems, but rather, how politically strong the lower and middle classes are, which determines what percent of national income they get.
Can monetary policy introduce distortions into the economy? There are times when it would be better to use fiscal policy. In the face of a prolonged stretch of insufficient demand, it would be best to put a check in the mail and send it to every citizen in the country. But the Republicans have opposed the use of fiscal action. Paul Krugman talked about this back in 2012:
One recurring complaint from commenters on this blog is that they can’t figure out where I stand on monetary versus fiscal policy as a response to a deeply depressed economy. Sometimes, they say, I declare that monetary policy is ineffective once you’re at the zero lower bound; other times I berate Ben Bernanke for not doing more. Which is it?
But it’s not a contradiction. Mike Woodford’s latest paper, especially taken in tandem with his paper last year at the Cambridge Keynes conference, actually explains it all.
What Mike demonstrates is the point that liquidity-trap worriers have been making for a long time – actually, ever since my 1998 piece. Current monetary policy is indeed ineffective in a liquidity trap; but there is still scope for central bank action in the form of credible commitments to keep monetary policy easy in the future, when the economy is no longer at the zero lower bound.
…What about fiscal policy? As Mike pointed out in his earlier paper, fiscal stimulus in a liquidity trap doesn’t require that you convince the market that you’re going to behave differently once the crisis is past. It doesn’t depend on expectations at all; the government just goes out and creates jobs. So it made a lot of sense to argue for stimulus as the main immediate response to the slump.
But isn’t fiscal stimulus also a hard sell politically? Yes, indeed – although the truth is that we did get some, and it probably had a major impact in softening the economic blow. And we would have had more if not for the scorched-earth opposition of Republicans, which is not a problem of economic analysis.
So what should well-meaning economists do now, with both fiscal and monetary policy falling short? The answer is, campaign on both fronts, trying to convince influential players both that austerity is wrong and that the Fed needs to start signaling its willingness to see more inflation before it raises rates.
And that’s more or less where I am.
During the debate that followed the crash of 2008, Krugman repeatedly said that fiscal policy would be useful to get the economy going. Republicans pushed back and said that the USA needed to worry about its debt, but reasonable people pointed out that debt wasn’t much of a concern when interest rates were 0%. A level of debt that would terrifying if interest rates were 10% is no real concern at all when interest rates are 0%. Still, the Republicans continued to fight against fiscal stimulus (and in 2016, when a Republican became President, the Republicans forgot about their worries about debt, and they started pushing through huge tax cuts that increased the debt, which suggests that the worries they expressed when Obama was President was really about sabotaging Obama. The Republicans were never really worried about debt, they were just pretending).
One clear result of the midterms is that we won’t have anything like a further round of stimulus. And this, in turn, means that the narrative all the Very Serious People will tell is that fiscal policy was tried, it failed, and that’s that.
But the real facts don’t at all support the conventional wisdom.
Actually, let me focus on an international comparison. You often hear the US experience contrasted with Germany: America, we’re told, went for Keynesian policies, while Germany chose austerity, and Germany did better.
But as far as GDP is concerned, Germany did not, in fact, do better:
Yes, Germany did better on employment — but this reflects policies that American conservatives surely don’t support, including employment subsidies, strong unions, and rules making it difficult to fire workers.
On television, and in the newspapers, there was an abundance of articles suggesting that fiscal stimulus didn’t work, and yet, in the academic literature, there was substantial research showing that fiscal stimulus did work. Again, Krugman’s comment in 2011:
I like this footnote, which gives you a sense of what has been going on:
3 For within-country evidence, see Chodorow-Reich, Feiveson, Liscow, and Woolston (2010); Suárez Serrato and Wingender (2010); Shoag (2010); Fishback and Kachanovskaya (2010); and Nakamura and Steinsson (2011). For cross-country evidence, see International Monetary Fund (2010); Council of Economic Advisers (2009); and Kraay (2010). For time-series evidence (as well as simulation-based evidence), see Hall (2009); Barro and Redlick (2010); Fisher and Peters (2009); Coenen et al. (2010); and Christiano, Eichenbaum, and Rebelo (2010). On this list, all but Kraay, Barro and Redlick, and Fisher and Peters implicitly or explicitly try to provide evidence about the case where monetary policy does not act to offset the effects of fiscal policy. With the exception of two of these three (Kraay and Barro and Redlick), the papers all suggest substantial effects of fiscal policy. As I describe below, this brief tour omits all work that predates the crisis.
Of course, all you’ll hear on TV is nyah-nyah-nyah the Obama stimulus didn’t work.
Again, the point is, the USA economy has been weak since the end of the 1990s, and its been especially weak since 2008, and what would help get it back to full strength would be sending a large amount of cash to every American (fiscal stimulus). Or the government could launch into an ambitious program of rebuilding the nations infrastructure, increasing the budget deficit and this allowing more fiscal stimulus. But the Republicans have opposed all forms of fiscal stimulus, so instead of fiscal stimulus, we have to rely on monetary stimulus to get the economy going again. Monetary stimulus isn’t as effective as fiscal stimulus would be, but it is the best we can do in the face of Republican opposition. And monetary policy has returned the economy to something that resembles normal, albeit a weak version of normal. The fact that wages are not rising faster suggests that the economy still has a lot of slack, and we will need a lot more stimulus before we get back to full strength.
* Mind you, I do have some criticism of how the CPI is calculated. In 1995 the Republicans put the BLS under intense pressure to increase the way it weight possible quality improvements, so I believe the CPI has been slightly biased to the low side since 1995. The BLS does not do nearly enough to calculate the loss of quality from many services. Food is allowed additional additives, this is not considered a loss of quality, and organic food is not considered a giant leap of inflation because it is counted as a separate category. In 1945 all tomatoes were organic, nowadays organic tomatoes cost much more than non-organic tomatoes, but food inflation is counted as if the tomatoes in 1945 were not organic — there are many such small lapses that leave the CPI open to criticism. Probably the most dramatic source of bias is regarding health insurance, as someone pointed out:
My health insurance hasn’t gone up that much in the last 5 years on per month basic. The difference is instead of the $10 copay on day 1 that I used to have, I now have a $3K deductible and my in-network choices have been cut in half.
Having said all that, it would be a small bias. Even if you thought the bias was fairly large, on the order of 0.4% or 0.5% a year, this decade would still be noteworthy for low inflation.
Conversations like the above are the main reason I’m opposed to any populist variant of democracy, which is to say, 99% of democracy. We live in an increasingly specialized world, where more and more tasks have to be handled by those who have some specific knowledge of how a process works. Most people have strong opinions, but no actual knowledge of how things are defined, or how things work.Source