My latest essay explains my outlook for inflation.
But in 2020, the U.S. Budget deficit was 17.9 percent of GDP (source here) and in 2021 it will be 9.8 percent of GDP. According to the helicopter drop model, this should raise prices by more than 25 percent.
Nice artice, but perhaps Japan a bit too easily dismissed. See also Australia. Switzerland. Indonesia. Where is the inflation?
On several occasions over 40 years, Martin Feldstein advised shorting US Treasuries. He erred each time. How can such a smart fellow be wrong for four xonsecutive decades?
Some bottlenecks now. Beyond that, some moderate inflation to hurdle the Covid-19 disaster probably worth it.
Are taypayers becoming more indebted? The Federal Reserve funnels interest back to the Treasury. Who owns Japan’s debt? The Bank of Japan. Are taxpayers indebted?
Orthodox macroeconomics is straining.
Perhaps the Fed should buy back even more debt.
Every single dollar the Fed uses to buy up the debt must be used to buy something else, or it must be stored as cash at a bank that then must use it to buy something else that earns an income to cover the costs of running the bank. The Japanese used a large portion their yen from such central bank operations to buy US treasuries. Surely you can see the problem here?
The problem from the point of view of the Japanese taxpayers?
You mean they now own a lot of US Treasuries? How does that hurt them? They are collecting interest from the US?
Besides, I though Japanese bought US Treasuries as they ran chronic trade surpluses with the US.
BTW, the Swiss National Bank printed up $800 billion in Swiss francs to buy foreign sovereign bonds, to hold down the exchange rate of the Swiss franc. No inflation to speak of in Switzerland. That is a huge amount for Switzerland, more than 100% of GDP.
What gives?
What’s the endgame on accumulating assets?
So I look at my 401k and my home and they are skyrocketing in price. What can I do with that?
As far as I can tell the two options are:
1) Pass these assets on to my children
2) Sell and spend it on consumption
In some ways I think these are kind of the same because if I sell I’m presumably selling to someone else’s kid. It’s really just a question of what I demand in return for the asset (and like my wives brother, you can just as easily ask your kid to pay implied rent on a house that is passed down).
So what we are talking about with asset prices is implied demand on future production that I intend to consume. I believe that if I sell my stocks I can buy 100 widgets based on current market prices.
But if everyone thinks that and there aren’t enough widgets to go around when we all want to sell then either the price of widgets goes up, the price of stocks goes down, or both.
That “we all want to sell” part seems the key. Until we all try to use our stocks to buy widgets at once, we can all plausibly believe that our stocks will be worth 100 widgets based on current market prices.
And so it seems to me that inflation in non-assets tends to raise its ugly head when all of a sudden everyone holding a certain asset wants to convert it into some consumption item with inelastic demand, usually produced by a foreign country. Energy is the obvious example in the 1970s.
Housing seems to be a combination of asset and consumption in this scenario. Rents aren’t up as much as asset prices (though I would note as recent homebuyer that all the best properties to live in are for sale, not rent). It seems like we are heading for a scenario where the only people who can afford a house are people who get assistance from their home owning parents.
I’ve often advocated for massive helicopter drops of Bryan Caplan’s book “Selfish Reasons to Have More Kids” within border towns and poor immigrant communities. Let’s give it a try! Please consider contributing to this worthy cause.
In the last 20 years:
Right after 9/11 on 10/31/2001:
Intergovernmental Holdings: $2.48T
Debt Held by the Public: $3.33T (of which $0.54T, 16% Held outright by Fed)
Most recent:
IG: $6.18T (up 149%)
Pub: $22.02T (up 561%) (FedR: $5.07T, 23%, up 839%)
The 5-year breakever inflation rate expectation series unfortunately only starts in Jan 2003. But in the five years after 10/31/01, the average CPI inflation rate was 2.1%. Today the expectation is 2.5%. Not a big change in that rate, not really out of the range of cyclic volatility. But a massive change in public debt and monetization.
While their theory is not very coherent or convincing, these kinds of numbers are the best things the MMT’ers have going for them, and the hardest thing for the proponents of the other theories to explain away.
My guess would be that the answer lies with expectations and recent experience.
Most people expect the current situation to be somewhat temporary due to the COVID pandemic. In 2022, the budget deficit may be back down to Trumpian levels, in the 4-5% of GDP context, and the Fed will likely be done buying securities. Moreover, most people who know about such things would expect the Fed to tighten monetary policy if there appears to be a sustained rise in inflation.
Combine this with recent experience.
Recent experience has been that inflation has been low and manageable. It seems that for a lot of products, suppliers have opted to allow shortages rather than raise prices. I suppose the reason for that is to avoid alienating customers who are not used to price hikes. As a singular example, the MSRP of a Playstation 5 is $499, but glancing at eBay, the market price is probably closer to $899. Sony could decide to hike the price to $599 or $699, closer to the market clearing price, but if things revert to normal, many gamers would hate Sony for ‘gouging’ them. As supply picks up, say in 2022, they’d cut the price back to $499 but the brand damage would be done.
You can see this in the trades as well, in which if you need work done on your house, you might have to wait for months rather than face higher prices forcing down quantity demanded. Likewise, restaurants and other places facing labor shortages due to Biden bucks see that situation as temporary. If labor costs were expected to be permanently higher, the only reasonable course of action is to pay up to fully staff and adjust prices accordingly.
If the US has a couple of years of at least high single digit inflation, however, I suspect that many more firms would be happy to let their products go up in price sharply. Sony could raise the PS5 to $599, then to $649 in 2022, $699 in 2023, $749 in 2024, etc. At this point, expectations would change, large annual price hikes of goods, services, and labor would become the norm, and you’d require a hard reset from the Fed a’la 1980-1982.
Every single construction project my wife runs is way over budget. The biggest part of that being that the same contractors are being chased by the same stimulus dollars, and everyone wants to spend now now now because they know if they don’t get it out the door right away they will lose out on the fed bucks.
I don’t know if that will ever show up in the price of potatoes, but it sure has made construction expensive.
Inflation will be like a dam breaking- first a trickle, then a small stream, then a small river, then disaster- the history on this is unequivocable. I am 55 in July, I might not live to see the disaster. If you had asked me even 2 years ago, I would have confidently predicted I would not live to see it, but I now think there is about a 1/3 chance I will live to see it. The Fed, and Japanese and European central banks, are in a corner from which there is no escape.
Before we get a 5 year “average” of 5% or more, which I’d call a stream, we should be seeing an increase – where is the multi-quarter trickle.
Raising the min. wage to $15 will cause lots of prices to jump, which won’t quite be inflation but will look like it and be measured like it – but might well be temporary as the Fed says.
Similarly with gas prices going up, single industry supply restriction cost increase – with varying effects on all other prices of goods, especially (and transport of goods).
“history on this is unequivocable.” – Well, we have never in history had any company with a market cap of over $1 TRILLION, and now we have a few, with Apple (first). This is asset hyper-inflation, and history does NOT show how rich investment asset hyper-inflations end.
I fear war and – plague – but money printing seems one of the ways to minimize economic based desires for war.
No US hyper inflation without shortages of food – watch the Big Mac index.
There is a difference between a helicopter drop of currency and the Fed expanding banks reserves which receive interest.
When the Fed buys interest-earning Tbills from banks with interest-earning reserves, it is a pure asset swap of one very short term, safe, liquid, interest-earning asset with another. It is more of an M&M world than a quantity theory of money world. To a close approximation, it makes no difference.
If the Fed buys a long Treasury, there may be a portfolio substitution effect which reduces the term premium in the bond market. That is the sole channel for boosting aggregate demand. Not every economist accepts the theory. But it is not a helicopter drop.
To go back to an old debate, let the government expand spending, financed with deficits, but no change in the money supply. There may be a small rise in the price level, but no sustained rise in inflation. The higher debt will require higher taxes eventually.
The analysis needs to be modified when the short rate is stuck at near-zero. In a liquidity trap, what difference does it make between money and bills?
Also you need to ask about long-term policy. Is the helicopter drop once and for all, but permanent? Or will the money be withdrawn soon? Or will there be helicopter drops every day?
I think it’s a helicopter drop in the sense that the US government is handing out checks and those checks are effectively being financed by selling bonds to the Fed, which pays for them by tapping on a computer. There’s some distinction between the Fed and US Gov, but not much of one. If you combine their balance sheets, the asset and liability cancel out, and the net effect is that someone on the Fed typed on a keyboard and now hundreds of millions of Americans have greater spending power.
And yes, I think long term expectations are key. Most people likely believe that COVID-related things (stimulus, supply chain problems) are temporary aberrations, and the rest of the 2020s will see a more normal economy: 4% NGDP growth, 4% of GDP deficits, 4% (+/-) unemployment, 2-3% inflation. In fact, it’s my current baseline scenario. I would have given a 1-2% probability to a high rate / high inflation world in 2019, now I give it a 10-20% probability. That probability is only as low as it is because I don’t expect the Fed to let the inflation genie out of the bottle while the 70s and 80s are still in living memory.
Now if some politicians really into basic income decide to give each American adult a $2,000 check each month and has the Fed pay for it, then I’d fully expect double digit inflation, and hyperinflation if the check itself was indexed to inflation.
Thinking of Econ 101, aren’t the price level and quantity supplied determined by where the demand and supply curves meet? If so, the economy is receiving large boosts to demand, which should shift the demand curve to the right. Absent any changes in the supply curve, that would lead to both higher prices and higher quantity supplied. However, there should be large changes in the supply curve coming soon, expanding capacity and shifting the supply curve to the right. A shift to the right in the supply curve should lead to higher quantity and a lower price.
Now throw those two changes together, and what do you get? You certainly get more quantity. Where the price ends up is determined by the relative magnitude of shifts in supply and demand. Where is the argument that supply won’t be able to keep up with demand? I could be convinced that supply in the construction of dwellings cannot keep up with demand and that alone might be enough to really raise the overall price level. Maybe in some commodities as well. But it is only where government action restricts supply that I think prices will rise substantially.
Zero hedge HT on this fine GreatRecession blog post:
https://thegreatrecession.info/blog/inflation-foreshock-fed-not-fazed/
“The Fed, on the other hand, can do nothing about shortages, and it is shortages that cause people to bid up prices not possession of money. If you really want something, you don’t pay more for it in a competitive marketplace just because you have more money; but you will pay more to get what you need or want in a badly broken marketplace riddled with shortages if you have the money to do it. Money creates the ability to bid up prices; but shortages create the need. The company that offers to pay more, finds a way to get limited goods transported to its warehouses. It then sells those goods for much more to desperate customers who will pay more to get what they need or greatly want.”
It is great – since it agrees with me. And makes sense about shortages.
“Because the various causes of supply shortages are not problems the Fed can fix, inflation is not transitional. The Fed is out to lunch. Shortages because freight won’t be up to demand for months to come. Shortages because US producers don’t have parts that they cannot get shipped to create what is needed over here. Shortages because US producers cannot get employees who make more products. Shortages because demographics changed abruptly under COVID to where people are relocating all over the US, creating massive product demand and resource demand in order to build new houses and new infrastructure. Shortages because of businesses that do not even exist any more due to COVID lockdowns.”
Tho here, with fewer businesses, prior excess demand (gluttony?) is also being reduced, thus dampening the total demand and reducing the shortages.
His blog posts are full of insights about the top 1% are getting most of bread being created by the Fed, with most middle class just getting crumbs.
OK, I’m not an economist, so there are probably all sorts of things that I am missing, but I don’t think the analogy of the helicopter drop works quite the same way as we might expect, especially when there are dynamic forces in an economy working against an increase in the general price level (i.e., my understanding of inflation).
Take Japan in the 1980s. The government pursued an easy monetary policy, and there was a huge expansion of credit (see article Arnold linked to above). But the yen was strengthening against the dollar much of this time. It went from 254/dollar in Jan 1985 to 127/dollar in Jan 1989, which must have had a deflationary effect on consumer prices. (Japan had little inflation during the late 1980s.) All the extra money went into asset inflation, the great Japanese bubble.
Then there was the Asian financial crisis of the late 1990s. Money had been pouring into Asia for the purposes of investment, some sterilized by individual governments, some not. Before the crisis, consumer price inflation was moderate in most of the Asian countries involved, despite the large amounts of new money. Once again, most of the inflation went into assets, especially real estate. Since most of the local borrowing had been denominated in dollars, when the dollar strengthened, the whole structure collapsed. But excess money did not necessarily raise the price level in some regular proportion; it was diverted by other forces into asset inflation.
It seems to me that we are in a similar episode. We’ve had quantitative easing and other actions by the Fed that have led to major increases in the money supply, but for more than a decade inflation has been below the Fed’s desired level. A lot apparently depends on how the new money enters the economy. (This is the problem with the analogy of the helicopter drop: that suggests an even dispersal of new money rather than a targeted infusion that affects some parts of the economy more than others.) But all the extra money hasn’t been getting into the hands of the consumers, who would then bid up prices for consumer items. Instead, the money has been finding its way into assets—for years the stock market, more recently real estate. COVID, of course, had messed things around somewhat, and the enormous stimulus payments may in fact contribute to consumer-price inflation, but it’s still not clear whether the recent rise in inflation is now systemic or only temporary. That is, have the forces (whatever they may be) that have been suppressing consumer price inflation for over a decade been defeated or merely temporarily interrupted?
Whatever the case, if Japan and Asia are relevant models, this likely will not end well.
Arnold, would this fit your paradigm? Assume that in your 1 trillion dollar economy there are 1 million property owners. If the government puts 100 billion dollars into the banks while outside there is a deflationary economy, what if each property owner found the value of his house rise by 100,000 dollars?