Never reason from an inflation rate change
By Scott Sumner
In a new post, Tyler Cowen is skeptical of Paul Krugman’s claim that higher inflation hurts the rich. Brad DeLong also expresses some skepticism. I agree with Cowen and DeLong, but would like to quibble with this comment in Tyler’s post:
We all know that inflation is extremely unpopular with voters. We also observe that inflation remains extremely unpopular in a variety of northern European economies, which typically have more egalitarian distributions of income (though not always wealth) than does the United States. In any case the top 0.1 percent in those countries has less wealth per capita than in the U.S. and, at least according to progressives, less political influence too.
There are many subtle issues that need to be considered here. The impact of a once and for all change in the price level is very different from a permanent change in the growth rate. The impact of expected changes in the price level are different from the impact of unexpected changes. The impact of inflation in a depressed economy is different from the impact at full employment. Most importantly, the impact of inflation from a demand shock is very, very different from the impact of inflation resulting from a supply shock.
After 30 years of teaching, and observing the results of many public opinion polls, it’s clear to me that very few people even know what inflation is. Around 1990 Americans were asked if inflation was higher or lower than 10 years earlier. They said “higher” suggesting they confused inflation with the “cost of living.” In addition, they tend to hold their own income constant when contemplating “inflation,” which means that poll question results aren’t really about “inflation” they are about supply shocks, i.e. lower real income. Guess what, falling real income is unpopular! I often ask my students; “If all wages and salaries rise by 10%, and all prices rise by 10%, has the cost of living actually risen?” About 99% say no, even though the correct answer is yes. Most have taken multiple macro courses. Please stop asking the public questions about “inflation.”
There’s a risk here that people might assume; “inflation is unpopular, ergo expansionary monetary policy in unpopular.” However whereas supply shocks reduce real output, expansionary monetary policy (in a slack economy) boosts AD, and hence real GDP. Higher real GDP is much more popular (or at least less unpopular) than falling real GDP. American’s liked the 1960s better than the 1930s. The ECB’s tight money policies aren’t well understood by the eurozone public (or even the eurozone experts, for that matter.) But the results of that policy are wildly unpopular everywhere except perhaps Germany and Austria. Even the Netherlands is depressed. Sweden isn’t in the eurozone, but the Riksbank’s tight money policy is about to drive a very fine reformist center-right government out of power. Tight money is Sweden is very unpopular. Inflation is too low, indeed almost zero. Greece has no inflation—how’s that working out for the voters?
Forget about inflation; focus on the popularity of things that might cause inflation—supply shocks, monetary stimulus, etc.