DeLong: Is Inflation the Right Battle?

Brad DeLong asks whether we should be more concerned with inflation or with unemployment:

Is inflation the right battle?, by J. Bradford DeLong, Project Syndicate: The Federal Reserve and other central banks are coming under pressure from two directions these days: from the left, they are pressured to do something to expand demand and hold down global unemployment; from the right, they are pressured to contract demand to rein in inflation.

This is a situation ripe for trouble, because one of these two diagnoses must be wrong. If the world’s central banks raise interest rates while the major problem is insufficient global demand, they might cause a depression. If they do not raise interest rates while the major problem is inflation, they might cause ... a stubborn wage-price spiral like that of the 1970’s that can be unwound only with a later, deeper depression.

I see the left as being correct — this time — in the global economy’s post-industrial North Atlantic core. Headline inflation numbers are the only indication that rising inflation is a problem, or even a reality. The ... indicators of developed-country nominal wage growth show no acceleration... And “core inflation” measures show no sign of accelerating inflation either.

The United States is experiencing a ... financial meltdown... In normal times, the Fed’s response — extremely monetary stimulus — would be highly inflationary. But these are not normal times. Indeed, the Fed’s monetary policy has not been sufficient to stave off a US recession, albeit one that remains so mild that many doubt whether it qualifies as the real animal.

The European Central Bank’s response has been analogous to the Fed’s, but less forceful... And in Western Europe, too, GDP is now declining.

In brief, the major central banks on both sides of the Atlantic have responded to the financial crisis, but they have not overreacted. ...

Yet headline inflation is soaring, and, not surprisingly, gets the headlines. This reflects three developments. First, the world has, for the moment at least, reached its resource limits, and we are seeing a big shift in relative prices... The result of this relative price shift is headline inflation.

Second, inside the US, the return of the dollar toward its equilibrium value is carrying with it import price inflation. Costs to US consumers are rising and making them feel poorer, not because they have become poorer, but because the previous pattern of global imbalances exaggerated their wealth. Global rebalancing is painful for American consumers, and shows itself as higher headline inflation. ...

Finally, ... China’s policy of export subsidies through currency manipulation was always bound to become unsustainable in the long run because it was bound to generate substantial domestic inflation. Now it is also generating substantial pain for other developing countries as China’s booming economy outbids them for resources. But it is politically impossible for the Chinese government to alter its exchange-rate policy under pressure without some “concession” from the US, and a tightening of US monetary policy could be sold as such a “concession.”

But this overlooks what ought to be at the center of the discussion: higher US unemployment right now ... offers few benefits, if any, for stabilizing US prices. Nor is a US that cuts back on import purchases more rapidly in the interest of any export-oriented developing economy – including China.

Comments

[Dickeylee]

Unemployment? Why fight unemployment? Isn't unemployment good a keeping that dreaded wage/price spiral from getting out of hand? "Unemployment is good" is the CofC mantra...

[Matt]

Yield curve looks OK to me, no inversion, relatively smooth. When the economy could use credit, credit demand will show up.

[Jobs for all]

I do believe the old East Germany had 0% unemployment. Any reasons we shouldn't adopt the East German policy?

[a]

Increase demand! Consume more! Yet again economists tell people what they want to hear - that the way out of their problems is to take another trip to the mall and spend some more.

[Uhm, no]

And so far, so good - but you'll never admit you were (and are ) wrong... Without policy intervention, we'd be in bad shape.

And anyone who thinks that the only way to increase demand is through consumption has no business even trying to comment. Traditionally, that is not what monetary policy stimulates, and fiscal policy does not have to be directed at consumption unless you are ideologically opposed to anything but tax cuts - but that's political, not economists, and few thought this was a good idea - remember? Or do you just want to keep trotting out the same lame - and wrong - protests? You mischaracterize what economists say in terms of policy prescriptions, then knock it down. Is that an intentional mischaracterization, or is it becasue you don't really get it? I'll be generous and assume that the one sour-note criticism arises from lack of understanding.

[Global Decoupling]

"If the world's central banks raise interest rates while the major problem is insufficient global demand..."

US domestic demand has been higher than US productive capacity for some time now. Perhaps China should encourage more domestic demand, but not the US.

[Headline]

"Headline inflation numbers are the only indication that rising inflation is a problem, or even a reality."

Headline CPI directly affects the standard of living of citizens. Headline CPI increases are enemy number one.

[a]

Um, yes!

"And anyone who thinks that the only way to increase demand is through consumption has no business even trying to comment." I guess "um no" is an economist! He knows what other people think without even asking! Personal consumption is 70% of American GDP. How dare I not mention the other 30% in a comment of 3 lines?

"Traditionally, that is not what monetary policy stimulates..." Lovely word, "traditionally." Now ask, what has American monetary policy since the dotcom crash *actually* stimulated?

"Fiscal policy does not have to be directed at consumption." Of course it doesn't. Yet how has fiscal policy for the moment actually been directed? Why at personal consumption! 100 B USD into the pockets of American consumers in Q2 2008. All to make them feel better about themselves and just possibly vote Republican in the 2008 Presidential election. Of course those economists who supported the tax rebate won't say that that was the intention, but that's the *effect*. (Also note BDL's post was essentially about monetary, not fiscal, policy...)

"Or do you just want to keep trotting out the same lame - and wrong - protests?" I'll have to keep trotting out the same protests so long as economists like BDL trot out the same lame - and wrong - ideas!

"You mischaracterize what economists say in terms of policy prescriptions, then knock it down. Is that an intentional mischaracterization, or is it becasue you don't really get it?" Oh c'mon, for every economist there's a different policy prescription. Perhaps you could make the discussion concrete by mentioning what your policy prescriptions were or are? For instance, the tax rebate in Q2 2008? The bailout for Bear Stearns? The bailout for Countrywide in Q3 2007? A bailout for Fannie and Freddie (how much would you have the government spend?) A bailout for the FDIC? I imagine you'll say you're for infrastructure investment. (Who isn't?)

"I'll be generous and assume that the one sour-note criticism arises from lack of understanding." Yes, but the question is, whose lack of understanding?

[kharris]

"...one of these two diagnoses must be wrong."

Not necessarily. Both diagnoses may be right. The problem is that we can only treat one malady at a time. Even if we have inflation and slack demand growth, we still have to choose which one to treat.

The Volcker solution was to deal with inflation, but inflation in his time was broad-based and rapid, with expectations high, wage inflation wide-spread and automatic inflation adjustments much more common. Policy makers had gotten to the end of their rope, and nothing was working till Volcker tightened monetary policy. Today, we have inflation highly concentrated in commodity prices (which are now coming down), none in wages, very few automatic mechanisms to transmit inflation, inflation expectations creeping up slowly. Conditions are very different, but the only precedent we have if Volcker.

When I see either side pretending the other side is stupid or corrupt, I immediately imagine a pot yelling at a kettle.

[kharris]

"...one of these two diagnoses must be wrong."

Not necessarily. Both diagnoses may be right. The problem is that we can only treat one malady at a time. Even if we have inflation and slack demand growth, we still have to choose which one to treat.

The Volcker solution was to deal with inflation, but inflation in his time was broad-based and rapid, with expectations high, wage inflation wide-spread and automatic inflation adjustments much more common. Policy makers had gotten to the end of their rope, and nothing was working till Volcker tightened monetary policy. Today, we have inflation highly concentrated in commodity prices (which are now coming down), none in wages, very few automatic mechanisms to transmit inflation, inflation expectations creeping up slowly. Conditions are very different, but the only precedent we have if Volcker.

When I see either side pretending the other side is stupid or corrupt, I immediately imagine a pot yelling at a kettle.

[Inconsistent]

Why is it that when relative price changes threaten to make the headline CPI fall, new money is created to offset the relative price changes. When relative price changes threaten to make headline CPI rise faster than the target, new money is created anyway because relative price changes are dismissed as unimportant.

This is inconsistent. If relative price change mediated alterations of the CPI from target matter, they matter equally in both directions. If relative price change mediated alteration in CPI from target don't matter, they don't matter in both directions.

One would have to suspect that those who gain from new money creation are rationalizing the creation of new money under all circumstances.

[Standard of Living]

"...very few automatic mechanisms to transmit inflation..."

Which is another way of saying that changes in headline CPI directly reduce the standard of living of most people. The lucky few who first receive newly created money live high though.

[Iconoclast421]

This analysis is very typical of the fallacy-laden tripe that has been spewed over the last 5 years as America has slid further and further into "The Abyss That Doesn't Exist." Even now we still have these sorry 'debates' about whether this recession is "the real animal." In 2008, such statements can only be called willful ignorance.

Anyway, to correct a few points... Inflation has nothing directly to do with employment numbers. Inflation is simply a matter of monetary policy. So the paragraph about the two diagnoses is just gobbledegook.

And secondly, yes, the best solution for America is actually to have a dramatic Increase in unemployment. America is suffering from a serious misallocation of resources. All the Starbucks and McDonalds and pop-up suburban homes and the gas guzzling SUVs have all caught up to us. Not to mention all the time wasted on hollow material pursuits, to the detriment of educational, spiritual, and social cohesion. It can not continue. The only way to fix the problem is a complete community transformation based on making much better use of fossil fuels. Smaller vehicles and fewer television screens. Failure to do this will result in America becoming a third world country. And no doubt we will have to be on the losing end of another world war before completing the 5 stages of denial. These kinds of social changes are not going to happen when everyone is working menial jobs. The symptoms will only get worse until war and collapse becomes inevitable.

[Whinerw]

People who complain about headline inflation are just whiners.

[jamzo]

when prices for commodities increase business raises prices and the "inflation is coming, inflation is coming" drum beat becomes stronger and stronger as people begin to press for higher wages to meet their increased cost of living

while the context is different the underlying dynamics have not changed, financial entities create monetary crisis and the battle for who is going to pay begins

thank you prof delong for keeping your eye on the ball

[Barry]

kharris: "When I see either side pretending the other side is stupid or corrupt, I immediately imagine a pot yelling at a kettle."

After 30 years o supply-side economics, and seven years of bushnomics.......

[bakho]

Don't give all credit to Volcker for whipping inflation.

http://www.eia.doe.gov/bookshelf/brochures/gasolinepricesprimer/

Look at Figure 4. After a long period of declining real gasoline prices, real gasoline prices increased through the 70s until the early 80s when Carter's energy conservation efforts more fully kicked in. Then toward the end of the 90s, we see the return of higher gasoline prices and the return of inflation (AG raised interest rates at the end of the 90s).

Using monetary policy to address energy linked inflation does not work. That should really be the message of the 1970s and the 2000s. The cure for inflation is to change the demand for oil which is most easily done through conservation and efficiency increases, not monetary policy.

If you are a business and one of your inputs is scarce and starting to price you out of the market what do you do? You look for ways to change the process to lower reliance on the input. in this case, oil. Ideally you want interest rates to be affordable to cover the transition costs of overcoming the barriers to a new process.

Bush is an idiot.

[a digs the hole deeper]

a

Your response on consumption - the 70% thing - should convince anyone who knows anything about economics there's no need to read on. If you are asserting that changes in consumption are the main driver behind cycles, you really don't know what you are talking about. Go read up (consumptinis large, but it's very stable, investment drives cycles - and remember, housing is investment, not consumption in the accounts so calling or suggesting it's consumption just makes you look dumb).

So anyone who doesn't mention th eother 30% misses the whole picture - as you did.

So it's pretty clear the lack of understanding is yours.

[Julio]

bakho:

If you are a business and one of your inputs is scarce and starting to price you out of the market what do you do? You look for ways to change the process to lower reliance on the input. in this case, oil. Ideally you want interest rates to be affordable to cover the transition costs of overcoming the barriers to a new process.

Bush is an idiot.

"If you are a business and one of your inputs is scarce... in this case, oil."

What if oil is one of your outputs?
Is Bush an idiot?

[bakho]

Then Julio-

You agree that Bush is a tool of Big Oil?

[Julio]

bakho,

Yes, that's where my comment was headed.
I think dismissing him as an idiot (but perhaps well-meaning) is too kind.

[a]

"If you are asserting that changes in consumption are the main driver behind cycles..."

Sorry, I wasn't and I'm not. You make wild claims about what I'm thinking and what I'm asserting. Is this a general problem that you have?

"So anyone who doesn't mention the other 30% misses the whole picture - as you did." The whole picture of what? I understand that you have a need to appear superior and condescending - so I guess I'm right that you are an economist - , but I'm afraid you need to learn how to refer clearly. And perhaps you have to consider the possibility that you are thinking of one picture and I am thinking of another.

Bye.

[Blissex]

BDL writes:

«In normal times, the Fed’s response — extremely monetary stimulus — would be highly inflationary»

But indeed these are normal times, and the Fed is causing high inflation, but in assets and in China and India, because assets, China and India are where investors see the best opportunities.

Money is fungible, and there is no reason to think that free money from the Fed*mart ("always low interest rates - ALWAYS") should be used for productive investment in America; it can well be used for asset price bidding wars and for productive investment in China and India.

It just happens that the main beneficiaries from ever rising asset prices and ever rising investment in China and India fueled by very low interest rates are the wealthy.

People who pretend to still think is vulgar keynesian terms are idiots, it is easy to see through their misleading arguments.

«First, the world has, for the moment at least, reached its resource limits, and we are seeing a big shift in relative prices as the global economy responds appropriately by making labor and capital cheap and oil and other resources expensive. The result of this relative price shift is headline inflation.»

This analysis is limited because it contrasts the relative scarcities of labor/capital vs. resources. But there is the big elephant in the room: the price of money, and the relative price of different currencies.

The enormous swings in the relative values of currencies driven by enormous changes in interest rates matters also as much as the change in terms of trade between labor (ever more relatively abundant) and capital/resources (ever scarcer).

[Francois]

After 20+ posts here, not one word about how corrosive unemployment and underemployment can be to our society.

So long for the pretense that we are caring people.

[Francois]

If the "we should care" argument does not hold water, let's try this:

“Liberty requires opportunity to make a living, a living decent according to the standard of the time, a living which gives man not only enough to live by, but something to live for.”

--Franklin Delano Roosevelt acceptance speech at the Democratic convention, Philadelphia 1936.

What does History teaches us about people who don't have something to live for? What happens when their number reach a certain threshold?