Email List Topic: Why Are We Not in Hyperinflation?
[UPDATE below.]
On a private list of Austrian economists, someone asked about Krugman’s recent back-patting on the issue of interest rates and CPI inflation. Here’s what I said:
(1) I regret that I have been one of the Austrians most guilty of prematurely sounding the (price) inflation alarm. In my defense, I first started going nuts in late 2008, when M1 did indeed rise significantly. Then in early 2009, after Obama was inaugurated, there were prominent lawmakers saying the banks had a duty to make loans to small businesses etc. to justify their TARP bailout. So at that point, we had every reason (except to always expect the opposite of what politicians are claiming a program will do…) to expect M1 and M2 to continue growing.
(2) Even after the slowdown in M1 and M2 growth, I didn’t back off my “call,” because I thought it perfectly obvious that the Fed had no exit strategy, that once the $1 trillion in excess reserves started leaking out, the Fed wasn’t going to destroy the banks by selling off all of the Fed’s MBS etc. I thought if it were obvious to me, it would be obvious to everyone on Wall Street, and they would price this into things, the dollar would fall, etc. etc. I blame my study of backwards induction at NYU.
(3) I think one big thing going on in all this, is that we are seeing Cantillon effects to the Nth degree. This is probably an oversimplification, but think about it: The economy is in a shambles, and Bernanke gives a trillion dollars in new money to investment bankers. What’s going to happen? They’re not going to rush to the store to buy milk and eggs. No, they’re going to buy financial assets, and indeed we saw the stock market go up 40% after Obama got in, which makes absolutely no sense. We have also seen gold setting records, which makes perfect sense too. But we haven’t seen CPI go up. In retrospect, is that really surprising? The people who buy milk and eggs are still broke; they didn’t get the trillion dollars. So there’s no reason to expect CPI to spike in the near future, and thus the Wall Street traders were right not to bid up [UPDATE: the implied price inflation expectations derived from] TIPS yields etc.
(4) Krugman has a decent point: Not so much the Austrians, but the standard “free market” Chicago School types have been blasting the Fed and Obama from Day One, claiming that the money printing and stimulus packages will drive up interest rates and CPI. In contrast, Krugman (and DeLong) have been saying, “No, we’re in a liquidity trap, people want to hold money and Treasuries, etc.” So in terms of that narrow debate, Krugman can understandably feel like he won.
I intend to flesh this stuff out–it will certainly be a topic in the near future in the Lara-Murphy Report, if you want to see a carefully-researched analysis–in the coming months. But those are my quick thoughts.
I should add that the bookish von Pepe has been urging me for literally more than a year to stop focusing on the CPI as a measure of price inflation. For some reason I recently “got it” and have begun reading Gerald O’Driscoll’s excellent work in this area, such as this and this. [UPDATE: Duplicate link fixed.]
I think there are two reasons.
1) Elevated portfolio demand for money emanating originally from the fall 2008 meltdown but maintained subsequently both by regime uncertainty and fiscal policy. Fiscal policy is intended to slow the adjustment process and replaces consumers’ preferences with policy makers’ preferences. The result is that the information content of market signals is drastically degraded. Entrepreneurs are aware that market signals are “polluted” and can no longer be relied upon as a guide to resource redeployment. Entrepreneurs decide to keep their powder dry, awaiting the time when they can have more confidence in market data and their own expectations. According to this logic, fiscal policy is not just wasteful and ineffective (in the positive sense) but it specifically undermines, and potentially neutralizes, expansionary monetary policy, particularly where some restructuring in the economy is required. The regime uncertainty story is well known but what seems less well recognized is that, at least in the initial stages, it would likely elevate demand for money and thus be slightly deflationary.
2) Excess money balances in a highly uncertain environment, particularly after the damage to retirement savings, have been directed to purchasing existing assets rather than to consumption or new investment. The extent of this is limited however by the recognition that new investment and the recovery has stalled due to 1) and the resultant effects on the expected demand for money around the world (Europe, etc.). An asset sell-off ensues until such time as prices have fallen, things have been quiet enough for long enough that people allow themselves an element of optimism again and retirement saving pressures encourage investors back into the market. Bottom line though is that any excess money balances are showing up in asset or commodity prices rather than the CPI.
I seriously doubt the CPI numbers reflect the inflation most people are experiencing. It’s true that cash is trading at a premium because of all the recalculation that’s (trying to be) going on. However, my dollars certainly aren’t buying me more at the grocery store. And we’ve seen how CPI calculations are ignoring many dimensions of product debasement (such as narrower sheets of toilet paper).
We’re not in hyperinflation, but we don’t have a stable or defaltionary dollar either. The dollar now buys only 83 yen, when (IRRC) a year before it was in the 93-97 range.
Bob,
I think both links on O’Driscoll lead to the same article.
DRH, fixed.
I’m with Silas on this one. I think the only way you can say inflation is tame is if you don’t buy anything. Even though we have not seen massive inflation, we still see prices rises on us in everything we use on a regular basis. Commodities are at or near 52 week highs, my energy bills are higher, my grocery bills are higher, my entertainment expenses are higher, and the banks haven’t even begun to loan out the trillion in excess reserves. I have paid off all the debt my parents had and even though they don’t have any more cc bills they still need me to send them money because they can’t get ahead. They have cut expenses to the bare bones and paid down their debt and still can’t save. If things weren’t going up in prices they would be saving money at this point. What does it matter if the CPI says there is no inflation if our checks keep buying less and less each year? Go tell my grandma whose medical expenses keep rising through the roof that the CPI says there is little inflation. People who listened to you in 2008 about the coming inflation have been able to prepare for what is coming. It might not be as bad as you expected yet but what does that matter if it is still coming. I just look at it as the longer it takes to manifest the worse the consequences are going to be. It isn’t like Mark Thorton was wrong in 2004 when he warned about the bubble in the housing market because it took another 3 years to pop. The bubble in the dollar will pop at some point and until then we are getting bled dry by the so called non existent rises in CPI as our money keeps buying less and less. Half the people in this country are going to be broke and without family members to lean on when the shit hits the fan, and the longer this takes to happen the worse the problem will be. Don’t regret telling the truth because your time line didn’t pan out because your warnings will before the end.
Great reply.
Real people know that any increase in the money supply is inflation. But that’s a little abstract for most people. How about we measure inflation via the spread between income and a fixed basket of goods? That fixed basket could even be the CPI right now. Would this not be a better way of measuring purchasing power?
I’ve said again and again, the english muffin/ dill pickle inflation index has not receded, it’s gone up. That’s all that need be said.
Bob this is part of why I’ve gone from ABCT-Recalculation guy to a straight-up AD guy -> because of Scott Sumner. Sure recalculation happens, however the sticky-wages+higher-demand-for-cash model explains a ton. I’m partial to both, but I think Austrians should listen more to Steve Horwitz than Rothbard
Casey Mulligan, a Chicago School guy the Keynesians like to smack around, was not predicting inflation.
If we had decent M3 statistics, maybe we would see that old monetarism still works. Here’s Nick Rowe:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/10/was-milton-friedman-right-after-all.html
All this DeLong’s liquidity trap stuff sounds nice in theory, but after Lehman the relative price of safe but less liquid TIPS has tanked. This means that we had the shortage of money, not the shortage safe government bonds:
http://themoneydemand.blogspot.com/2010/10/brad-delong-and-flight-to-safety.html