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Thursday, August 22, 2013

Teaching about Inflation is Fun (but Dangerous)

One more -- Antonio Fatas is reevaluating how he teaches about inflation:

Teaching about inflation is fun (but dangerous): Teaching about inflation is fun. Most people who have never been exposed to macroeconomics before are surprised when you show the correlation between inflation and money growth in a large sample of countries. You then produce some data about some hyperinflation countries that include a picture of some bank note with lots of zeros (thank you Zimbabwe) and the students love it. ...
The notion that inflation is (mainly) a monetary phenomenon is new to many students and going through the history of inflation and monetary policy regimes is a very rewarding exercise for a teacher.
But there is a problem with the way we teach inflation: in many countries inflation has been under control for decades now. And this control does not come from the fact that monetary policy was anchored to a physical commodity such as gold but from the actions and credibility of the central bank. ...
In this environment, inflation is almost constant and the correlation between money supply and inflation is inexistent. But we leave this fact for the last five minutes of the class given how much fun it was to talk about Germany in 1923, Hungary in 1946 and Zimbabwe in 2008.
So given the way we have been teaching about inflation it is not that surprising that for the last five years some have been worrying so much about inflation or even hyperinflation as central banks balance sheets have grown very fast. [There is, of course, the mistake that many do of not understanding the difference between the monetary base and the money supply but I will leave that for another post.]
Next time I teach my macroeconomics course I will spend less time talking about inflation and if I talk about it, I will not show the picture of the one hundred trillion dollars note from Zimbabwe, instead I will spend more time about the incredible stability of inflation in many countries. ...

The point about the difference between the monetary base and the money supply is important. Money piling up in banks is not inflationary, it has to be spent to create the demand needed to force prices up. Having the money stockpiled and available makes people and businesses feel safer in bad economic times, but once things improve there's a danger that quite a bit of the pent up demand could hit the marketplace all at once creating large upward pressure on prices. So long as the Fed can vacuum up the money through open market operations, or hold it in place with mechanisms such as paying higher interest on reserves as conditions improve there won't be an inflation problem. I am confident the Fed can do this, my fear is that they will get antsy and start the process too soon which could harm economic growth.

    Posted by on Thursday, August 22, 2013 at 01:12 PM in Economics, Inflation | Permalink  Comments (39)

          


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