No price index can capture, down to a tenth or a quarter of a percent, the real change in consumer prices. The variety of goods and services, the shifts in demand, the subtle changes in pricing and quality are too complex to calculate precisely from month to month or year to year.
Pointer from Mark Thoma. The book is co-authhored by Christine Harper, which sort of reminds me of those “as told to” sports autobiographies.
Anyway, Volcker is arguing against trying to use monetary policy to try to fine-tune the inflation rate.
I think of people as acting on the basis of habit. The expect prices tomorrow to be about where they are today. This really helps in making the countless calculations about what to buy, which job to take, which business to start, expand, or fold, etc. To get people to believe differently and to change their way of calculating takes a lot of effort. When Mr. Volcker became Fed chairman, the U.S. government had managed this trick, creating a regime where everyone felt that they had to factor general inflation into their decisions. Getting back to a low-inflation regime was not an easy process.
Another habit people have is treating government bonds as net wealth. That is, when the government borrows $100 from X to give money to Y, Y thinks he is better off by $100 and X thinks he now has a $100 bond. Neither X nor Y puts the obligation to re-pay that $100 on his personal balance sheet.
But that habit changes when something makes the X’s start to wonder whether the government is really going to pay them back, or if it is only going to pay them back in inflation-ruined currency. Then things start to get ugly.
The point is that models of simple, continuous, linear behavior do not apply to fiscal and monetary policy. Instead, there are phase changes. We shift from a regime of predictably stable overall prices to high inflation. There is not much in between those two regimes. We shift from a regime where government debt is treated as risk-free from one in which it is treated as highly risky. There is not much in between those two regimes, either.
>Another habit people have is treating government bonds as net wealth. That is, when the government borrows $100 from X to give money to Y, Y thinks he is better off by $100 and X thinks he now has a $100 bond. Neither X nor Y puts the obligation to re-pay that $100 on his personal balance sheet.
Yeah but how often has this failed. like never
There is no Free Lunch — in the global sense, because somebody has to pay. But all of us have had Lunch paid for with Other People’s Money. Free to me is pretty close to Free. Developed democratic republic politics has become a search for popular lunches paid for with OPM.
The example is great for explaining the attraction to the Dem Party:
“when the government borrows $100 from X to give money to Y, Y thinks he is better off by $100 and X thinks he now has a $100 bond. Neither X nor Y puts the obligation to re-pay that $100 on his personal balance sheet. ”
The poor Y gets a Free Lunch! The rich X bond-holder gets Free, tax-free interest, with a risk-free “investment”. So who pays? The non-rich non-bond holders who are non-poor and who DO pay taxes. The normal folk (of both XX & XY sex). The poor and the rich seem to do OK, but the normal folk in the middle have to pay.
It’s already ugly in Venezuela, and it will get worse before it gets better. It will likely be a long time before it gets that ugly in the USA, but it’s not impossible in any 20-30 year period of terrible socialist policies.
When Mr. Volcker became Fed chairman, the U.S. government had managed this trick, creating a regime where everyone felt that they had to factor general inflation into their decisions. Getting back to a low-inflation regime was not an easy process.
And we still think we are not in a low-inflation regime and conservatives spent all of Obama years swearing INFLATION was coming!!! And it never did his entire term! (Higher today any time during Obama except maybe parts of 2012 but that might just be energy/oil driving it.)
However big question here:
Considering the Japanese experience the last 25 years or even the Obama years, why has inflation so controlled? It is really low inflation when every Econ textbook would have stated higher inflation would have occurred. Is it China and India controlling wages? Oil declining in spend amounts by developed world? Manufacturing automation is controlling good prices? Too much trust in government developed debt? Developed world in Huge Liquidity? (I am holding out for lower long rates birth rates controlling AD!)
I wonder.
Japan has issued a mountain of debt, up to 225% of GDP. Then the central bank printed money and bought back about half of that mountain of debt.
The problem in Japan is they can’t even get to 1% inflation.
The Reserve Bank of Australia operates with a 2 to 3% inflation band target. They have not had a recession since 1991. A few times inflation climbed into the 4% range and then sank back down into the target range. Today Australia has the same problem as Japan in that they can’t reach in their inflation target despite exploding house prices.
I think a central-bank makes a great mistake when they make a fetish out of extremely low rates of inflation. Probably, trillions of dollars of real output have been lost in the United States due to this sort of perspective revealed in this blog post.
It seems that additional credit piles into bottlenecks. In the 1960s/1970s the bottleneck was still labor. Especially labor with collective bargaining that could get COLA increases. So extra money/credit went there and higher labor costs = higher consumer goods cost.
In the modern era labor isn’t the restraint, at least mass consumer goods producing labor. Real estate is a bottleneck, so a lot goes into real estate. Medical care. Education. Any new money/credit that gets created goes there. Since many of these aren’t part of CPI (or not as direct a driver as the price of milk) we say we don’t have as much inflation. But if you want a house near good jobs, medical care, or to go to college things have gotten quite expensive.
In the modern era labor isn’t the restraint, at least mass consumer goods producing labor. Real estate is a bottleneck, so a lot goes into real estate. Medical care. Education.
Don’t education, medical care and rent show up with the CPI basket of goods? (I still don’t understand exactly housing prices) And the real price of Milk would have $4.20 in 1960 while the local Winco is $2.40 a gallon. (Probably loss leader low today.) Most food prices and family budgets spend a lot less on food.
I still wonder why Japan since 1990 or the US during Obama really did not have more inflation and my 1992 Econ degree really confused by this. (Yes I was Keynesian brainwashed)
Looking at the Obama years the US really did have an ‘Uncola’ economy and the big commodity fall from 2012 – 2014 solidified there was no real inflation in the hopper.
(Note Health care are tough because long term they have numerous procedures that were not doable 20, 30 or 40 years ago. And Housing outside of certain urban cities is contained these days and even in SoCal we are in the midst a drop for the next several years.)
“We shift from a regime of predictably stable overall prices to high inflation. There is not much in between those two regimes.”
To claim this should require some numbers: is 5%, 10%, 20%, 40% annual inflation “high”? I’d say yes for 20%, but no for 10%. Hmm, rule of 72 says that at 18% inflation, prices double in 4 years — one Pres. cycle. I’m willing to claim 18% and higher is “high inflation”, with less than 18% down to 4% as “medium”, and from 4% down to 1% as “low”, with below 1% as “essentially no” inflation = predictably stable.
Then I claim there’s many cases of 4-18% medium, and even quite a few 10-18% medium-high cases, where a country is in that range for 3 or more years. This S. Hanke view of 283% inflation in Venezuela — in 2013!
http://www.marketoracle.co.uk/Article43144.html
From 2005 – 2012, it looks like they were in the “medium” range.
Deregulation and privatization, ending the Chavez socialism, probably could have still avoided most of the problems, with a lot of economic problems. Now it’s a catastrophe — voted for by fairly rich, educated, democratic folk seduced by elites who support socialism. (Supported?)
Second point – on models. Successful economic models self-invalidate.
Any economic model which is used to allow investors to make higher returns will change the behavior of investors. As the investors are successful, more will copy this success, so the changed behavior will, in some uncertain time, invalidate the model.