"Does Stabilizing Inflation Contribute to Stabilizing Economic Activity?"
I have been a proponent of inflation targeting procedures. However, many people take that to mean that inflation stability should take precedence over the stabilization of output and employment, or that we should suppress wages to prevent inflation. Here's a simulated interview with Frederic Mishkin generated from a recent speech that tries to clear this up (see also "Divine Coincidence is Unlikely" and "Mankiw on "Divine Coincidence" in Monetary Policy"). There are also comments about the use of core rather than headline inflation to guide monetary policy:
MT: Thanks for agreeing to do this in the simulation. Let's start by defining what the Fed is supposed to do. What are the Fed's goals?
FM: The ultimate purpose of a central bank should be to promote the public good through policies that foster economic prosperity.
MT: And how is that expressed practically?
FM: Research in monetary economics describes this purpose by specifying monetary policy objectives in terms of stabilizing both inflation and economic activity. Indeed, this specification of monetary policy objectives is exactly what is suggested by the dual mandate that the Congress has given to the Federal Reserve to promote both price stability and maximum employment.
MT: Let's get right to the big question. Does stabilizing inflation mean that the Fed is less focused on stable output and employment?
FM: We might worry that, under some circumstances, the objectives of stabilizing inflation and economic activity could conflict, particularly in the short run. However, economic research over the past three decades suggests that such conflicts may not, in fact, be that serious. Indeed, stabilizing inflation and stabilizing economic activity are mutually reinforcing not only in the long run, but in the short run as well.
MT: You mentioned both the short-run and the long-run. Let's start with the long-run becasue there is less controversy there. What do theory and evidence tell us about the long-run tradeoff between inflation and unemployment?
FM: Both economic theory and empirical evidence indicate that the stabilization of inflation promotes stronger economic activity in the long run. Two principles underlie that conclusion. The first principle is that low inflation is beneficial for economic welfare. Rates of inflation significantly above the low levels of recent years can have serious adverse effects on economic efficiency and hence on output in the long run. The distortions from a moderate to high level of long-run inflation are many. High inflation can cause confusion among households and firms, thereby distorting savings and investment decisions. The interaction of inflation and the tax code, which is often applied to nominal income, can have adverse effects, especially on the incentive of firms to invest in productive capital. Infrequent nominal price adjustment implies that high inflation results in distorted relative prices, thereby leading to an inefficient allocation of resources. And high inflation distorts the financial sector as firms and households demand greater protection from inflation’s erosion of the value of cash holdings.
MT: So, high inflation leads to distortions which can impact growth. But what about the tradeoff?
FM: The second principle is the lack of a long-run tradeoff between unemployment and the inflation rate. Rather, the long-run Phillips curve is vertical, implying that the economy gravitates to some natural rate of unemployment in the long run no matter what the rate of inflation is.
MT: Then what determines the natural rate?
FM: The natural rate, in turn, is determined by the structure of labor and product markets, including elements such as the ease with which people who lose their jobs can find new employment and the pace at which technological progress creates new industries and occupations while shrinking or eliminating others. Importantly, those structural features of the economy are outside the control of monetary policy. As a result, any attempt by a central bank to keep unemployment below the natural rate would prove fruitless. Such a strategy would only lead to higher inflation that, as the first principle suggests, would lower economic activity and household welfare in the long run.
MT: What does the evidence say about all of this?
FM: Empirical evidence has starkly demonstrated the adverse effects of high inflation. In most industrialized countries, the late 1960s to early 1980s was a period during which inflation rose to high levels while economic activity stagnated. While many factors contributed to the improved economic performance of recent decades, policymakers' focus on low and stable inflation was likely an important factor.
MT: Now let's turn to the short-run. Is there a tradeoff there?
FM: Although there is no long-run tradeoff between unemployment and inflation, in the short run, expansionary monetary policy that raises inflation can lower unemployment and raise employment. That is, the short-run Phillips curve is not vertical. That fact would seem to suggest that achieving the dual goals of price stability and maximum sustainable employment might at times conflict. However, several lines of research provide support for the view that stabilization of inflation and economic activity can be complementary rather than in conflict.
MT: And it is that complementary nature of the tradeoff we want to highlight because that is where there is a lot of confusion over the conduct of monetary policy. How does this work, i.e. can you describe how the two goals of inflation and output stability might reinforce each other?
FM: Economists have long recognized that some sources of economic fluctuations imply that output stability and inflation stability are mutually reinforcing. Consider a negative shock to aggregate demand (such as a decline in consumer confidence) that causes households to cut spending. The drop in demand leads, in turn, to a decline in actual output relative to its potential. As a result of increased slack in the economy, future inflation will fall below levels consistent with price stability, and the central bank will pursue an expansionary policy to keep inflation from falling. The expansionary policy will then result in an increase in demand that boosts output toward its potential to return inflation to a level consistent with price stability. Stabilizing output thus stabilizes inflation and vice versa under these conditions.
MT: I see. What role do inflation expectations play in all of this?
FM: One critical precondition for effective central-bank easing in response to adverse demand shocks is anchored long-run inflation expectations. Otherwise, lowering short-term interest rates could raise inflation expectations, which might lead to higher, rather than lower, long-term interest rates, thereby depriving monetary policy of one of its key transmission channels for stimulating the economy.
MT: And how does this relate to the main question, the complementarity of inflation and output stability?
FM: The role of expectations illustrates two additional basic principles that help explain why stabilizing inflation helps stabilize economic activity: First, expectations of future policy actions and accompanying economic conditions play a crucial role in determining the effects of current policy actions on the economy. Second, monetary policy is most effective when the central bank is firmly committed, through its actions and statements, to a "nominal anchor"--such as to keeping inflation low and stable. A strong commitment to stabilizing inflation helps anchor inflation expectations so that a central bank will not have to worry that expansionary policy to counter a negative demand shock will lead to a sharp rise in expected inflation--a so-called inflation scare. Such a scare would not only blunt the effects of lower short-term interest rates on real activity but would also push up actual inflation in the future. Thus, a strong commitment to a nominal anchor enables a central bank to react more aggressively to negative demand shocks and, therefore, to prevent rapid declines in employment or output.
MT: You've mostly been talking about the response to demand shocks. Does any of this change, e.g. does the tradeoff return, if the shocks are from the supply-side of the economy?
FM: Unlike demand shocks, which drive inflation and economic activity in the same direction and thus present policymakers with a clear signal for how to adjust policy, supply shocks, such as the increases in the price of energy that we have been experiencing lately, drive inflation and output in opposite directions. In this case, because tightening monetary policy to reduce inflation can lead to lower output, the goal of stabilizing inflation might conflict with the goal of stabilizing economic activity.
MT: Given the recent oil and commodity price shocks we have seen, that isn't good news.
FM: Here again, a strong, previously established commitment to stabilizing inflation can help stabilize economic activity, because supply shocks, such as a rise in relative energy prices, are likely to have only a temporary effect on inflation in such circumstances. When inflation expectations are well anchored, the central bank does not necessarily need to raise interest rates aggressively to keep inflation under control following an aggregate supply shock. Hence, the commitment to price stability can help avoid imposing unnecessary hardship on workers and the economy more broadly.
MT: Good theory, but is there any evidence to support it?
FM: The experience of recent decades supports the view that a substantial conflict between stabilizing inflation and stabilizing output in response to supply shocks does not arise if inflation expectations are well anchored. The oil shocks in the 1970s caused large increases in inflation not only through their direct effects on household energy prices but also through their "second round" effects on the prices of other goods that reflected, in part, expectations of higher future inflation. Sharp economic downturns followed, driven partly by restrictive monetary policy actions taken in response to the inflation outbreaks. In contrast, the run-up in energy prices since 2003 has had only modest effects on inflation for other goods; as a result, monetary policy has been able to avoid responding precipitously to higher oil prices. Many factors were likely at work, but this experience suggests that inflation stabilization does not have to come at the cost of greater volatility of real activity; in fact, it suggests that, by anchoring inflation expectations, low and stable inflation is an important precondition for macroeconomic stability.
MT: Back to theory. How do modern models explain this evidence?
FM: Research over the past decade using so-called New Keynesian models has added further support to the proposition that inflation stabilization may contribute to stabilizing employment and output at their maximum sustainable levels. This research has also led to a deeper understanding of the benefits of price stability and the setting of monetary policy in response to changes in economic activity and inflation.
In particular, research has emphasized the interaction between stabilizing inflation and economic activity and has found that price stability can contribute to overall economic stability in a range of circumstances.
MT: What's the intuition behind this result?
FM: The intuition that leads to the conclusion that stabilizing inflation promotes maximum sustainable output and employment is simple, and it holds in a range of economic models whose policy prescriptions have been dubbed the New Neoclassical Synthesis. To begin, the prices of many goods and services adjust infrequently. Accordingly, under general price inflation, the prices of some goods and services are changing while other prices do not, thus distorting relative prices between different goods and services. As a consequence, the profitability of producing the various goods and services no longer reflects the relative social costs of producing them, which in turn yields an inefficient allocation of resources. A policy of price stability minimizes those inefficiencies.
MT: So, when some prices are sticky, monetary policy should attempt to keep relative prices at the values they would attain if prices were perfectly flexible hereby duplicating the flexible price outcome? How is this accomplished, by simply stabilizing all prices?
FM: There are several subtleties here. First, in some circumstance, relative prices should change. For example, the rapid technological advances in the production of information-technology goods mean that the prices of these goods relative to other goods and services should decline. Thus, the policy prescription refers to stability of the price level as a whole, not to the stability of each individual price.
MT: Then which prices should be stabilized?
FM: The New Neoclassical Synthesis suggests that only those prices that move sluggishly, referred to as sticky prices, should be stabilized. Indeed, these models indicate that monetary policy should try to get the economy to operate at the same level that would prevail if all prices were flexible--that is, at the so-called natural rate of output or employment. Stabilizing sticky prices helps the economy get close to the theoretical flexible-price equilibrium because it keeps sticky prices from moving away from their appropriate relative level while flexible prices are adjusting to their own appropriate relative level.
MT: So only the slowest moving prices are stabilized? Does that mean we should ignore prices that move around a lot - prices like food and energy - and focus on the "core" inflation rate?
FM: The New Neoclassical Synthesis does not suggest that headline inflation, in which the weight on flexible prices is larger, should be stabilized.
Monetary policy should focus on stabilizing a measure of "core" inflation, which is made up mostly of sticky prices. Simulations with FRB/US, the model of the U.S. economy created and maintained by the staff of the Federal Reserve Board, illustrate this point. To keep the simulations as simple as possible, I have assumed that the economy begins at full employment with both headline and core inflation at desired levels. The economy is then assumed to experience a shock that raises the world price of oil about $30 per barrel over two years; the shock is assumed to slowly dissipate thereafter. In each of two scenarios, a Taylor rule is assumed to govern the response of the federal funds rate; the only difference between the two scenarios is that in one, the federal funds rate responds to core personal consumption expenditures (PCE) inflation, whereas in the other, it responds to headline PCE inflation. Figure 1 illustrates the results of those two scenarios.
MT: Dude, you brought graphs to an interview? Cool! (oops, that didn't come out quite right, though I did think I saw the hint of a smile, but maybe not, anyway, he just ignores me and goes on)
FM (continuing): The federal funds rate jumps higher and faster when the central bank responds to headline inflation rather than to core inflation, as would be expected (top-left panel). Likewise, responding to headline inflation pushes the unemployment rate markedly higher than otherwise in the early going (top-right panel), and produces an inflation rate that is slightly lower than otherwise, whether measured by core or headline indexes (bottom panels). More important, even for a shock as persistent as this one, the policy response under headline inflation has to be unwound in the sense that the federal funds rate must drop substantially below baseline once the first-round effects of the shock drop out of the inflation data.
MT: Can you summarize what these graphs tell us?
FM: The basic point from these simulations is that monetary policy that responds to headline inflation rather than to core inflation in response to an oil price shock pushes unemployment markedly higher than monetary policy that responds to core inflation. In addition, because this policy has larger swings in the federal funds rate that must be reversed, it leads to more pronounced swings in unemployment. On the other hand, monetary policy that responds to core inflation does not lead to appreciably worse performance on stabilizing inflation. Stabilizing core inflation, therefore, leads to better economic outcomes than stabilizing headline inflation.
MT: Are the oals of inflation and output stability always perfectly aligned, i.e. do we have what some have referred to as a "divine coincidence"?
FM: Although the simplest sticky-price models imply that stabilizing sticky-price inflation and economic activity are two sides of the same coin, the presence of other frictions besides sticky prices can lead to instances in which completely stabilizing sticky-price inflation would not imply stabilizing employment (or output) around their natural rates. For example, in response to an increase in productivity, the real wage has to rise to reflect the higher marginal product of labor inputs, which requires either prices to fall or nominal wages to rise for employment to reach its natural rate. If both nominal wages and prices are sticky, a policy of completely stabilizing prices will force the necessary real wage adjustment to occur entirely through nominal wage adjustment, thereby impeding the adjustment of employment to its efficient level. Indeed, if wages are much stickier than prices, the best strategy is to stabilize nominal wage inflation rather than price inflation, thereby allowing price inflation to decline to achieve the required increase in real wages.
MT: Are there any other examples where the the output and price stabilization goals are in conflict?
FM: Fluctuations in inflation and economic activity induced by variation over time in sources of economic inefficiency, such as changes in the markups in goods and labor markets or inefficiencies in labor market search, could also drive a wedge between the goals of stabilizing inflation and economic activity.
MT: I can see the opponents of inflation targeting emphasizing the result that the two goals aren't always aligned in realistic models.
FM: These examples narrow the degree to which the recent findings of congruence between stabilizing inflation and economic activity apply in all cases, but they do not necessarily overturn the findings. The example of sticky wages would not invalidate the view that stabilizing inflation stabilizes economic activity if wages are sticky, for example, because they are held constant in order to operate as an "insurance" contract between employers and workers. And for many of the inefficient shocks that drive a wedge between the sustainable level of output and the level of output associated with price stability, monetary policy may be the wrong tool to offset their effects.
MT: So is it a no brainer, just stabilize inflation and go home?
FM: Central banks at times will still face difficult decisions regarding the short-run tradeoff between stabilizing inflation and output. For example, judging from the fit of New Keynesian Phillips curves, a substantial fraction of overall inflation variability seems related to supply-type shocks that create a tradeoff between inflation and output-gap stabilization. But the key insight from recent research--that the interaction between inflation fluctuations and relative price distortions should lead to a focus on the stability of nominal prices that adjust sluggishly--will likely prove to have important practical implications that can help contribute to inflation and employment stabilization.
MT: One last topic. How does the Fed stabilize the economy around the natural rate of output when it doesn't know for sure what that is? There have been mistakes in the past that have resulted in suboptimal policy.
FM: If a central bank errs in measuring the natural rates of output and employment, its attempts to stabilize economic activity at those mismeasured natural rates can lead to very poor outcomes. For example, most economists now agree that the natural unemployment rate shifted up for many years starting in the late 1960s and that the growth of potential output shifted down for a considerable time after 1970. However, perhaps because those shifts were not generally recognized until much later, monetary policy in the 1970s seems to have been aimed at achieving unsustainable levels of output and employment. Hence, policymakers may have unwittingly contributed to accelerating inflation that reached double digits by the end of the decade as well as undesirable swings in unemployment. And although subsequent monetary policy tightening was successful in regaining control of inflation, the toll was a severe recession in 1981-82, which pushed up the unemployment rate to around 10 percent.
MT: What does this mean for policy?
FM: Uncertainty about the natural rates of economic activity implies that less weight may need to be put on stabilizing output or employment around what is likely to be a mismeasured natural rate. Furthermore, research with New Keynesian models has found that overall economic performance may be most efficiently achieved by policies with a heavy focus on stabilizing inflation.
MT: Any final words?
FM: Because monetary policy has not one but two objectives, stabilizing inflation and stabilizing economic activity, it might seem obvious that those objectives would usually, if not always, conflict. As so often occurs with the "obvious," however, the impression turns out to be incorrect. The economic research that I have discussed today demonstrates, rather, that the objectives of price stability and stabilizing economic activity are often likely to be mutually reinforcing.
A key policy recommendation from the past three decades of research in monetary economics is that monetary policy makers must always keep their eye on inflation and emphasize the importance of price stability in their actions and communications. Doing so does not mean that monetary policy makers are less concerned about stabilizing economic activity. Rather, by appropriately focusing on stabilizing inflation along the lines I have outlined here, monetary policy is more likely to better stabilize economic activity.
MT: Thanks. I've been trying to make two points about monetary policy for a long time, that the Fed's use of core inflation is justified on both a theoretical and empirical basis, and that focusing on inflation stability does not come at the cost of output stability, and I apprecitaed the opportunity to have you help me make them one more time.
Posted by Mark Thoma on Wednesday, February 27, 2008 at 05:06 PM in Economics, Fed Speeches, Monetary Policy
Permalink TrackBack (0) Comments (30)
Subscribe to Feed
Why is it that unfunded wars never come up in these discussions?
The inflation of the 1970's was related to the need to "pay" for the Vietnam war and the expected (at least by me) inflation over the next several years will be related to the need to "pay" for the current wars.
One might say that the oil price rises in both cases are the result of the wars and thus the wars don't need to be taken in to account explicitly, but I haven't seen anyone making that claim.
I also don't believe that the Fed is an honest broker willing to balance the dual mandates of controlling inflation and keeping employment high. In every case over the past 40 years inflation has been the primary focus and unemployment has risen as a result. If there is going to be a new policy this time it will be a surprise.
The clients of the Fed are banks, the wealthy and the rest of the financial sector. Labor has no seat at the table, so it is unsurprising that the wealthy clients get a priority. Bernanke may not have the same business orientation as his predecessors, but if he is really going to change priorities he will have to overcome a lot of institutional resistance to do it.
Posted by: robertdfeinman | Link to comment | February 27, 2008 at 06:48 PM
I have a couple of questions for Mr. Mishkin. First, what if food and energy prices are rising steadily (and secularly) faster than other prices? Won't your concentration on so-called 'core inflation' put you behind the curve in fightng inflation? Secondly, how has the Fed done in the recent past in trying to manage the economy? Would they have done any worse just looking to maintain price stability, with no other consideration? Do you think Greenspan reacted too vigorously to spur the economy after the collapse of the stock market? It seems to me we have yet to see if the Fed's attempts to meet its dual mandate have done anything but postpone (and make worse) needed adjustments. It still strikes me as strange that the Fed should be trying to spur borrowing and spending when the U.S. currently has unsustainable excess demand (running a large current account deficit). Even if we avoid a recession through strong monetary policy actions now, will this set up an even greater crisis later? It reminds me of the old policy to prevent all forest fires. We learned later that they are a needed part of natural adjustments. I'm not sure we have advanced beyond the wisdom of Milton Friedman, when he advocated replacing the Fed with a simple rule of maintaining a steady rate of growth in the money supply.
Posted by: don | Link to comment | February 27, 2008 at 07:23 PM
We know that inflation has its free riders but then so too does deflation has another group of free riders. Ideally the money supply should increase in step with economic growth such that no one is a free rider. If you feel those with the power to increase supply are incapable of 'zero-flation' (or close enough to it) then the only solution then is to go back to gold and silver coins (and risk inflation/deflation on the vagaries of mining).
Posted by: Gil | Link to comment | February 27, 2008 at 09:47 PM
Absolute Price Stability - that's what central banks should aim for over the course of the business cycle.
And governments should aim to have zero net debt and zero net savings over the course of the business cycle too.
Bring those two together and I think you'll have a good economy. It's a pity that the Fed has been stoking inflation for the past 4 months and Bush and Congress have been racking up unsustainable deficits for the past 7 years (and more).
Posted by: One Salient Oversight | Link to comment | February 27, 2008 at 09:59 PM
Great interview...
While you're at it, why not hypothetically ask how to redesign the monetary mechanism so that it works as advertised? Ask why is the mechanism failing?
I have to question the part about the 'problem' with long term rates rising as short term rates fall. There needs to be a spread for there to be bank profit in leveraging and we all know the banks need profits right now.
The question is whether fiscal policy and/or exports will allow the economy to pay the higher long-term rates. So far seems not as loan demand seems to be falling.
Posted by: Winslow R. | Link to comment | February 27, 2008 at 10:18 PM
This apocryphal interview is both revelatory of and apologetic for the simple "core" con which dwells at the center of US dual-mandate monetary policy, the willingness to use inflation to create "fictitious wealth" in order to incentivize various weak economic actors to engage in behaviors that are not in their immediate or long term interests, specifically unrestrained consumption.
This fatuous repeated reference to the control of expectations rather than actual prices is as absurd as not worring about someone suffering from malnutrition simply because you have been able to convice him that he is not dying.
Mishkin, Bernanke and the other FOMC con men seem unaware that throughout the world fewer and fewer alert actors are listening to their lies and nearly everyone is attempting to slip out of their noose made of dollars.
Is there really any reader here who believes that Bernanke will raise any interest rate at any time during the remainder of his (hopefully truncated) term?
Be honest now.
Posted by: esb | Link to comment | February 27, 2008 at 11:23 PM
Is there really any reader here who believes that Bernanke will raise any interest rate at any time during the remainder of his (hopefully truncated) term?
Be honest now.
None believes he will raise rate. The script for this play was written long ago.
It is not the core/headline debate that is debatable now - the core itself is rising now. They are tolerating higher core inflation now. The entire charade of "core inflation is the one true thing" is shot to pieces now. Bringing up headline vs core now, is a strawman argument.
What Mishkin is glossing over, and Thoma is carrying water for Mishkin, is that while inflation may be transitory, its effects are accretive.
The Fed is attemting to inflate away the value of debts. It is the most unjust, arbitrary and capricious redistribution of wealth.
The capital (borrowed &) invested in housing in the past 3-4 years is not going to generate rents to pay that debt off. The owners are not going to see incomes rise to pay it off (imagine the productivity increases required to bring home price/wages into balance - aint gonna happen). There are not going to be enough high-income people to buy these houses off the current neck-deep in debt owners. So how is this debt going to be retired?
By inflation.
Who loses - the least powerful, who cannot demand wage increases, elderly on fixed income. The sanguine and cavlier attitude of economists who parrot the Fed line is unbelievable.
Who loses but does not realize it? The pseudo-rich, the house-owning, 401K saving, pretend-rich middle class, who collectively believe the delusion that nominal gains imply that they gained. While ignoring the corrosive effect of inflation on purchasing power and living standards.
Who gains - the people who got the money in the inflation cycle first - the pigmen on Wall Street, the hedge funds who borrowed at 1% and bought all the stocks first.
Now watch as the pigmen dump the assets onto a scrambling public who HAVE to take those off their hands at these inflated prices. (Watch Jon Stewart's interview with the ace-crook Greenspan )
This has already started - to bail out the hedge funds, the PBGC announced last week it is now buying stocks. From whom? Why from the over-leveraged about to be bust hedge funds. Your 401K and pension fund is next in line behind PBGC.
There was a time that maybe the Fed could have said to be in control, and it could adjust the supply of money to the need of the economy. Credit was under Fed control, and regulations on banks ensured that credit drove investment and production, and that generated income to pay off the debt. The cost of credit was risk-adjusted to take into account that some of these ventures could fail. But all that was long ago.
The Fed lost control of credit creation years back. Most of the credit created in the last decade was outside the Fed control, and for pure consumption, and blatant speculation in financial paper assets, not productive investments. This credit was NOT priced for that risk, and nor was margin demanded from the reckless. (See Buffet's comment on how derivatives make mockery of security margin requirements).
Now the Fed is inflating, so that asset values don't fall and all these speculators and pigmen dont have to suffer losses. Any argument that this is a normal monetary action, of a Fed in control of money supply, when in reality the Fed is aiding and abetting the pigmen in this plunder of wealth, is unconsionable.
The Fed is not saving the economy or seeking to maintain employment, it is bailing out the pigmen.
If the Fed were not Wall Streets bitch, it would let the pigmen bite dust, and drown with liquidity the remaining sound banks and whichever new ones that crop up to replace the corrupt ones. The fact it is not doing so, speaks for itself.
Posted by: bullbust | Link to comment | February 28, 2008 at 12:38 AM
Price stability (sticky prices) promotes economic efficiency. Maintaining inflation above zero to allow short term moderating of economic cycles comes at a cost to that efficiency. Note the drop in long term GDP growth, and long term transfer of purchasing power from workers/savers/retirees to borrowers. That is, the standard of living of borrowers has increased, while the standard of living of the other groups has declined.
Posted by: Efficiency | Link to comment | February 28, 2008 at 04:32 AM
Mark - there is an oped by Allan Metzler (endorsed over at Greg Mankiw's place) that says: (a) the FED's job is to stabilize prices; and (b) this FED is making the same mistakes as the alleged mistakes of the 1970's. IMHO, he's wrong about (a), he's wrong about today's FED, and he's wrong about monetary policy from 1974 to 1979. But maybe this one is right up your ally.
Posted by: pgl | Link to comment | February 28, 2008 at 07:28 AM
effy
"the standard of living of borrowers has increased, while the standard of living of the other groups has declined."
circular causation can not be put
on a finite time line
i think aristotle said something like that
on his way to infinite regress
at any rate
get thee to a vickrey site !!!!
dialects obtain
where the yang of lending
becomes itself the ying of borrowing
good and bad l imply good and bad b
want a hard currency simulation contract
get your deal indexed
Posted by: paine | Link to comment | February 28, 2008 at 07:56 AM
Allan Metzler ???
talk about a blast from the shucked off past
this soulful proprietor
of a galloping 70's
midas price muffler shop
ahh for a return
to worship ing
our sacred monetary base
Posted by: paine | Link to comment | February 28, 2008 at 08:00 AM
effy
"Price stability (sticky prices)"
would these were
one and the same meme
Posted by: paine | Link to comment | February 28, 2008 at 08:01 AM
the problem of a run away price level
can be solved by setting an optimal
price level change path
using a mark up cap and trade system
problem
it would corralllll
our wild stallions
of limited liability
at least in a closed system
or an open one with exchange rate
full balance targets
we can end the corporations'
great escape clause
from
wage share raising contract forces
and even as we pump up job demand
to chock full choak fnear levels
who sez
there's an absolute margin of profit floor
i say
widows cruse the profit ink
and i bet
we'll get more tech change
faster and better and more economically
Posted by: paine | Link to comment | February 28, 2008 at 08:10 AM
mark
the posts list of inflation terrors
is for the nursery
only a generation not forced thru the 70's gauntlet
could actually believe
in an open economy like ours now is
this weimar nitemare scenario
lies .... necessarily
on the other side
of any really full employment macro policy
the forced enemia of corporate macro policy
the dismal dodrums
of
the hocus pocus niaru
with its cyclical but still chronically
sub possible output/job gap
my image
a cycle that uses true full employment as a ceiling it touches at best for a few peak quarters
and then gets strangled by macro induced
jobicidal credit policy
Posted by: paine | Link to comment | February 28, 2008 at 08:18 AM
its like pretending
turning on or off
a sprinkler system
is an act of naturte
just like a rain storm
Posted by: paine | Link to comment | February 28, 2008 at 08:31 AM
"What Mishkin is glossing over, and Thoma is carrying water for Mishkin, is that while inflation may be transitory, its effects are accretive"
ahh
like the chinese drip torture
short rate induced price level up ticks
that don't trigger serious long ternm expectational changes at the product producing firm price decider level
but nick away at existing bond values
you poor puppy
buy stocks pal
Posted by: | Link to comment | February 28, 2008 at 08:36 AM
don
uses the build up
of nasty
very conflagration friendly
underbrush
in a managed fire suppression system
what a metaphor for macro mangement
very paleo-austrian
Posted by: paine | Link to comment | February 28, 2008 at 08:41 AM
Absolute Price Stability - that's what central banks should aim for over the course of the business cycle.
And governments should aim to have zero net debt and zero net savings over the course of the business cycle too.
salient
are you suggesting inflation phases
fully countered by deflation phases
and deficit phases fully countered by surplus phases
if so here's some possibly relevent history
the isle of laputa
tried that policy back in 1723 -1728
and found it ... 'largely unworkable '
so they turned
back to trying
to find
a perpetual motion machine
to power their flour mills etc
Posted by: paine | Link to comment | February 28, 2008 at 08:48 AM
short rate induced price level up ticks
that don't trigger serious long ternm expectational changes at the product producing firm price decider level
but nick away at existing bond values
you poor puppy
buy stocks pal
Stocks? During inflation? Ha.
If the "poor puppy" was in sympathy, no need. I was in RICI before you heard of it, if you get the idea.
If you think that $ bonds are held by the well off, and they are going to get hurt by inflation, then you definitely don't have a clue.
Posted by: bullbust | Link to comment | February 28, 2008 at 10:20 PM
This is a good idea Mr. Paine. Would you be willing to help by writing your Congressman, and requesting that PBGC pensions be indexed for inflation? Well over a million people are losing the pensions that they worked decades for, because the PBGC does not make CPI adjustments. Thank you.
Posted by: PBGC Pensions | Link to comment | February 28, 2008 at 11:35 PM
Many are. I am as well. Many politicians nod to the notion, but do not really support it. Other factors pertain.
Practicably it can run against popular sentiment and therefore political opinion. The ECB (European Central Bank) is taking a great many hits recently for Inflation Targeting.
Inflation is a quilt-work in Europe, not a fairly uniform pattern as stateside. The Euro has still not integrated European economies to the extent original thought in the matter had predicted.
But, each leader of a EU-country that is suffering from extensive degradation of the employment figures is pointing an accusing finger at Jean-Claude Trichet, the ECB president, for not lowering interest rates. Trichet replies that the underlying inflation rates do not permit the Bank to do so. But, he is taking one helluva beating.
So, the political polemic goes on, whilst the economic one leaves no doubt that Trichet, and the ECB directors, are correct in their assessment.
I am aware of the realty market in France. My opinion is that it is overheated (due to historically low i-rates) and higher rates are necessary to cool it off. The average Frenchman, assailed by continuing reports of company dislocations and despite the fact that unemployment has actually declined over the past year, is not persuaded.
Economic wisdom rarely penetrates the skull of popular thinking, I'm afraid. Not anywhere, it seems. We must be careful about the words Consumer Propensity. It is not just a vague phrase to describe the willingness or not of consumers to spend.
It describes a way of living, which is far more rooted in the Socio-economic values of humans than we may think.
Posted by: Lafayette | Link to comment | February 29, 2008 at 03:37 AM
bullbust: On the topic "who loses" -- one big class of losers is people who have been engaging on a "deal" where they have advanced something they cannot take back thereby losing all their leverage, i.e. those who have spent their lifetime working and who have made concessions in the expectation of a comfortable retirement and/or workplace guarantees.
Unfortunately, the about only defense in such a situation I can see is to be cynical and make sure you don't work too hard. I think there is evidence of this in an increasingly widespread drop in "work ethic" and eagerness to go the extra mile that appears to have gone on for a while.
Posted by: cm | Link to comment | February 29, 2008 at 10:47 AM
Call me a doomsday reactionary cynic, but I have a question for FM and MT.
What if NAIRU is at a politically unsustainable level? What do you do then?
Serious systems thinkers have noted that you could supply the entire world supply of manufacturing goods from the capacity residing in East Asia alone. What does this mean for the blue collar worker in the West?
i.e. It implies that NAIRU is approx 20% or more. Can a non-inflationary policy be politically sustainable in such times? If not, what should be the way forward?
Economics is all about the allocation of scarce resources, but what happens when "making a living" and "having the income to sustain a decent human life" are the scare resources?
Posted by: Meh | Link to comment | February 29, 2008 at 03:42 PM
Meh: It appears to me that e.g. the healthcare capacity (as in "potential") of the US is not fully used. Likewise for other areas -- infrastructure maintenance, beautifying local parks etc.
Western (not just US) society (should I say "we") appears to be boxed into a corner where the "markets" are unable to match supply of labor and willingness to demand for work. Presumably in part as that demand is not "paying demand" as required by the mainstream economic "paradigm".
The scarcity "chokepoints" are the profitability requirement, and the lack of a labor distribution mechanism that is considered "equitable".
Unfortunately I'm not aware of any social model that has pulled this off -- i.e. harnessing spare labor capacity in such a way that the respective workers are not looked down upon or conscripted by force.
Posted by: cm | Link to comment | February 29, 2008 at 06:34 PM
Meh..."Serious systems thinkers have noted that you could supply the entire world supply of manufacturing goods from the capacity residing in East Asia alone. What does this mean for the blue collar worker in the West?"
At one time, most people were engaged in farming. Now 2% can feed the entire nation. Technological improvements mean that goods manufactured today will be produced by fewer people over time. New products/services must be found for people to produce. The same principal applies to foreign trade. If manufactured goods are made more efficiently overseas, we must make something else to trade for them.
Posted by: The Only Constant is Change | Link to comment | February 29, 2008 at 07:37 PM
"Indeed, if wages are much stickier than prices, the best strategy is to stabilize nominal wage inflation rather than price inflation, thereby allowing price inflation to decline to achieve the required increase in real wages."
That would seem to be the case today. Median wages are too sticky for the middle class to benefit from technological efficiency. An added benefit would be all consumers would gain from productivity improvements, not just the first in line to receive newly created money (borrowers).
Posted by: Sticky Wages | Link to comment | February 29, 2008 at 07:44 PM
The only constancy in life is change
Your point is moot. The above is never going to happen. So, its impact upon NAIRU will be unfelt totally and only to the extent already impacted.
For the above to happen, you must presume that absolutely all manufacturing is labor cost elastic, which it isn't. When all manufacturing flows to the one nation (or several) nations with the lowest labor costs, then inevitably those costs are readjusted upwards.
Japan is a prime example. In the early 1950s, America was worried that Japan would flood America with cheap products. You were not obviously around at that time.) A Buy America was sponsored vigorously by the American governments was well as Business. All that brouhaha came to nothing and American industry survived the onslaught -- by renovating its industrial mix of goods and services.
Besides, this dislocation of labour occurs because of the nature of the manufactured product. Most products that have moved to SE Asia are textile and low-tech. Or lower-tech such as the assembly of PCs from commodity components. (The mistake we make is thinking that CPUs and Disk-drives are hi-tech and therefore rightfully ours to build. The design, yes, is hi-tech -- but manufacturing is much lower-tech.)
It was inevitable that the Far East Tigers move upwards in technical proficiency. After all, we've been training their engineers for decades. Not all these engineers immigrated permanently to the US (or Europe).
A concrete example: The US Air Force, to everyone's disbelief, has today awarded at 35 billion dollar contract to European Airbus for the provision of the next generation Fueling Tanker. Does that mean a dislocation of jobs to Europe funded by the US government? (Horrors! Bring out the gallows!)
Not really. Airbus was able to beat Boeing at its own game, but partnering with Northrup (which was in dire need of a big contract to remain in business) in order to manufacture in dollars. A very great percentage of the jobs are therefore dislocating not from the US to Europe, but from Boeing to Northrup.
In fact, that's not happening either, since Boeing has its hands full delivering Dreamliners for the foreseeable future. And, the jet engines -- a very great part of the total expenditure -- come from either GE or Pratt & Whitney, both stateside.
My point: Let's not jump to economic conclusions that depend upon circumstances that remain static. The only constancy in life is change. But, we must move constantly in the right direction. Manpower skills that do not improve inevitably atrophy -- or dislocate to more favourable climates.
It behooves America's blue-collar workers to improve their skills and talents. But that does not mean necessarily that they must change the colour of their collars from blue to white.
Posted by: Lafayette | Link to comment | March 01, 2008 at 12:14 AM
I liked the simulated discussion because it is a very good summary and exposure of the wishful thinking of the authorities.
Anyhow I am particularly amused by this little piece:
«The experience of recent decades supports the view that a substantial conflict between stabilizing inflation and stabilizing output in response to supply shocks does not arise if inflation expectations are well anchored. The oil shocks in the 1970s caused large increases in inflation not only through their direct effects on household energy prices but also through their "second round" effects on the prices of other goods that reflected, in part, expectations of higher future inflation.»
Very funny indeed, because the clever economy of truth here is that this applies only, even in theory, to a closed economy. Because if the inflation expectations are anchored in the USA but not say in China or Saudi Arabia, things can get pretty different.
However even as to purely domestic anchoring, a very beautiful quote that gives away the whole current game of the Fed (by contrast):
«The Federal Reserve had to show that when faced with the
painful choice between maintaining a tight monetary policy to
fight inflation and easing monetary policy to combat recession,
it would choose to fight inflation. In other words to establish
its credibility, the Federal Reserve had to demonstrate its
willingness to spill blood, lots of blood, other people's
blood.» [Mussa, "American Economic Policy in the 1980s",
University of Chicago Press 1994].
This is a quote lifted from Andrew Glyn's excellent "Capitalism
Unleashed" (Oxford University Press 2007).
Posted by: Blissex | Link to comment | March 01, 2008 at 12:58 AM
«It behooves America's blue-collar workers to improve their
skills and talents.»
Why? Shouldn't they improve their cost base instead?
Because it is possible to hire Malay or Chinese workers that
have the same skills and talents, and who can be paid 1/10th of
the USA wages because the cost of living in Malesia or China is
1/10th of the cost of living in the USA.
The problem with USA workers is not that their skills and
talents are low, it is that they don't have a capital-based
productivity advantage that justifies the much higher living
costs they have to pay, because the same capital is available
in countries with much lower cost bases.
Posted by: Blissex | Link to comment | March 01, 2008 at 02:02 AM
"The problem with USA workers is not that their skills and
talents are low, it is that they don't have a capital-based
productivity advantage that justifies the much higher living costs they have to pay..."
Yes. Non safety regulation, de jure monopolies, hidden taxes, etc... drive up the cost of living. The cumulative effect is quite dramatic. Bridges to nowhere and requiring licenses to move furniture sound innocuous singly, but add too many of them and the cost of living can become higher than the median person can reasonably earn. Overtime becomes the only solution.
You are right L, manufactured imports only account for about 10% of domestic consumption. It will never reach 100%. Technological change is a far greater factor in forcing change of careers.
Posted by: The Only Constant is Change | Link to comment | March 01, 2008 at 06:30 PM