CEPR - Center for Economic and Policy Research

Multimedia

En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press The Washington Post Is Confused About Inflation, Economists Are Not

The Washington Post Is Confused About Inflation, Economists Are Not

Print
Thursday, 17 April 2014 07:42

In an article reporting on a speech by Federal Reserve Board Chair Janet Yellen, the Post told readers:

"One of the puzzles currently confounding economists is why inflation has remained so low even as the recovery has picked up steam. The Fed set a 2 percent inflation target but its preferred measure of price changes shows inflation is about half that."

Actually economists are not at all confounded by why inflation has remained low. The predominant view of inflation is that the change in the rate of inflation depends on the level of unemployment. Since nearly all economists believe the unemployment rate is still above its trend level, they expect inflation to be falling, not rising. In fact the bigger mystery from the standpoint of standard economic models is why the rate of inflation has not fallen more. (The answer is that wages and prices tend to be sticky going downward.)

Anyhow, the confounding is only at the Washington Post. The low inflation rate is not something economists have trouble explaining.

 

Comments (9)Add Comment
...
written by skeptonomist, April 17, 2014 10:52
Actually economists are extremely confused about inflation, and the history of inflation in economics is that of failed predictions and futile policies. Monetary policy fanatics have claimed that central banks can control the money supply and inflation, but the banks have never actually been able to do either, in either direction. In the last recession dropping federal funds to zero and buying long-term bonds in QE were supposed to pump money into the economy and bring about a strong recovery. It didn't happen, so unemployment remains high. Actually high unemployment certainly does not automatically cause low inflation - they were both high in the 70's and 80's as the Fed failed to control inflation. Anyway, if we ignore that and say that inflation is low because unemployment is high, we should ask why unemployment is high despite maximal efforts by the Fed. Why haven't the Fed's measures increased investment, reducing unemployment and presumably causing higher inflation? Isn't Bernanke an economist? He certainly didn't understand the lack of effect that his measures would have.

Krugman invokes the magical "liquidity trap", but what does this ultimately mean other than that economists don't have an answer in terms of monetary policy to a bad recession? Actually even in 2002 in a relatively mild recession he was saying that the Fed could not speed recovery other than by causing a housing bubble - and a housing bubble is what we got.

Now monetary-policy theorists, in an attempt to save the dogma that central banks control economies, are pushing the idea that central banks can in effect cause inflation by decree, which in turn is somehow supposed to cause increased investment and/or demand. There is no empirical evidence to support either part of this "theory". It is based on conjecture about how people react to inflation and interest rates and to the declarations of authorities about both, and economists do not have enough knowledge of psychology to predict economic behavior in this way (nobody does). Both sides of the inflation argument take it for granted that the Fed could control inflation if it actually did increase above the target (whatever that might be) but the evidence from the real world is that it does not control inflation. It is partly faith in this supposed control that causes inflationistas to keep calling for increases in interest rates.
Deflation
written by Tyler, April 17, 2014 11:03
Thanks for explaining why we're not experiencing deflation. Is it accurate to say "We'll know we're in a depression when deflation starts"?
...
written by fuller schmidt, April 17, 2014 11:56
Here's hoping that's satire, skeptonomist, but why post it here?
@skeptonomist
written by Ronald Pires, April 17, 2014 12:36
The monetarists have it wrong because their definition of money is wrong. They need to define it as accountants do, and not as something that simply appears out of nowhere. QE didn't work because according to accounting theory, it was merely a set of bookkeeping adjustments, and did not at all involve the creation of any new money.
why only focus on supply side inflation?
written by pete, April 17, 2014 12:44
There are two sources of inflation. The first is the supply side, as when the economy is at full steam and the costs like labor rise, forcing prices up. The second is the demand side, when the central bank issues more money then needed to keep prices stable, and there are upward pressure on prices. Eventually this leads to higher input costs as well. The confusion is that macroeconomics cannot distinguish the source of an inflation, and hence cannot predict one. In some cases, where the veil between the treasury and the central bank is nonexistent, the treasury can skip the bond issuance and simply fund the government with cash...this leads to hyperinflation as the amount of cash needed rises with inflation. That is typical demand side inflation which scares folks like the Germans.

Keynesian-monetarists like Yellen suggest using the demand side. Inflate prices, so that firms are profitable, and hire more workers at current wages. This is the post Bretton Woods outcome. Wages have barely kept pace with inflation.
@skepto
written by pjm, April 17, 2014 3:15
I think you are making something of non sequitur leaping from the inadequacy of monetarist theories about inflation to Krugman and the liquidity trap. The point about the liquidity trap argument is that it places Krugman more squarely back in the Keynesian camp (and anti-austerity) camp. So it is hard to see how it is an apology (or support) for mainstream monetarists, largely because it seems irrelevant. Is your argument that Krugman is insufficiently MMT so that everything he says is junk? Hmmm.
...
written by liberal, April 17, 2014 3:20
Ronald Pires wrote,
They need to define it as accountants do, and not as something that simply appears out of nowhere.


Actually, money does appear out of nowhere: banks create money out of thin air when they make loans. Sure, when they do that there's something on the other side of the ledger, but that doesn't mean that banks are reserve-constrained. And empirically, banks aren't reserve-constrained; rather, they're capital-constrained.

skeptonomist wrote,
Actually economists are extremely confused about inflation, and the history of inflation in economics is that of failed predictions and futile policies.


The main problem is that economists, for the most part, don't understand that the story about how fractional reserve banking works is, in the main, wrong.

There's also the problem you note, that people believe this fairy tell about outsized effects of expections.
...
written by liberal, April 17, 2014 3:25
pete wrote,
The second is the demand side, when the central bank issues more money then needed to keep prices stable, and there are upward pressure on prices.


Well, Pete, if there's virtue in consistency, you have it, since you're consistently wrong.

The central bank can print as much money as it wants to, but if no one spends it into circulation, it won't lead to increased demand and inflation.

In some cases, where the veil between the treasury and the central bank is nonexistent, the treasury can skip the bond issuance and simply fund the government with cash...this leads to hyperinflation as the amount of cash needed rises with inflation. That is typical demand side inflation which scares folks like the Germans.


Why oh why would we ever listen to the stupid Germans? For some reason that's not apparent, they choose to remember only one part of their monetary history, and ignore all the other parts. Not to mention maintaining their own employment by exporting deflation to the rest of Europe. They're probably the last party in the world anyone should listen to regarding monetary matters.
Bills Conundrum
written by Larry Signor, April 17, 2014 10:17
I think, like most folks, that the Phillps Curve is inadequate on a marginal basis. However, the disconnect we see today may be a measurement distortion. If the curve holds true then we are substantially above full employment, as Dean and Jared Bernstein point out. I think they are correct and we haven't fully thought out the curve when the economy transitions to a paternalistic system.

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.

busy
 

CEPR.net
Support this blog, donate
Combined Federal Campaign #79613

About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

Archives