The Corner

Re: Economists and Inflation: A Puzzle

A reader makes these interesting points:

You very accurately described the consensus view that economists and markets do not view inflation as a particular threat at this time.  You then wrote, however,

Besides placing undue faith in the Fed’s ability to time perfectly any necessary anti-inflationary measures, the consensus suggests that the nation’s central bank now has the heretofore undiscovered ability to increase the money supply without creating inflation.

The Fed has increased the monetary base, but the monetary base is not the money supply, which also depends on the money multiplier.  The Fed has not increased the money supply — properly understood — at abnormal rates. As you discussed, the money multiplier is currently very low because banks desire to hold excess reserves, which earn very modest interest at no risk. 

See M2, for example.

On his blog Free Advice in September, the Pacific Research Institute economist Robert Murphy argued that inflation is already here but economists are missing the signs. “From [December 2008] until August 2009, the unadjusted CPI level has increased 2.7%, which translates to an annualized increase of just over 4%,” Murphy wrote. He acknowledged that “ten-year yields [on Treasury bonds] are…low” but added that the price of gold has increased enormously. “Why do we assume that TIPS [Treasury Inflation-Protected Securities] traders are genius forecasters, but gold traders are morons?” he asked.

I guess that I am not convinced choosing data points to make inflation appear to be high or low or whatever.  Does it look high here?

 

BTW, you mentioned M1 in your short piece in the Corner but you linked to a graph on the monetary base.  M1 has not been useful for over 10 years because of the practice of “sweeping” demand deposits into time deposits at the close of business.  M1 fans have largely turned to looking at MZM. 

 

Further, I don’t think that gold traders are morons.  I do think that there is considerable uncertainty about inflation — in both directions – and that gold prices rise with such uncertainty.  We do know that gold has many more determinants than Treasuries, which only have 2 (essentially):  US growth and US inflation.  How thick is the gold market compared to the market for US Treasuries?  I am guessing that the Treasury market is much, much thicker.  We know that the value of Treasuries outstanding is much larger than the value of gold and it is easy to believe that much gold is never traded — e.g., the gold plating on the visors of fighter pilots or the gold in my teeth.

(Is there still gold in dental fillings? Never mind, you get the point.)

The St. Lawrence University economist Steven Horwitz agrees both that inflation is already happening and that it is widely misunderstood. Monetarists, he says, were “too focused on aggregates like ‘the’ price level, which led economists to ignore the way inflation could distort individual prices at the microeconomic level, causing resource misallocation in the process.”

If we can agree that low interest rates sometimes facilitate asset price bubbles, let’s also agree to call this phenomenon something other than “inflation.”  Inflation is a sustained rise in the general price level.  If Professor Horwitz wants to raise the alarm about asset price bubbles, he needs to say so more clearly.

Because of this tendency, bursting government-created bubbles leads to the creation of new ones. The real lesson may be that inflation is not only a monetary phenomenon but also a political one. Which makes it that much more difficult to predict, much less control.

It looks to me like inflation hasn’t been much of a problem for the last 25 years; it has been fairly low and stable.  Whether this will continue is — as you point out — a political question.  See this.

I appreciate e-mails like this one. Inflation is a very complicated issue and I remain puzzled by it. 

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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