Why debates over inflation are pointless
In a recent post I suggested that one could argue that the entire increase in per capita income over the past 50 years was pure inflation (and hence that real GDP per capita didn’t rise at all.) But also that one could equally well argue that there has been no inflation over the past 50 years. The official government figures show real GDP/person rising slightly more than 150% since 1964, whereas the PCE deflator is up about 6-fold.
Some people believe that inflation is a fairly straightforward concept—the average percentage rate of increase in the price of good and services over a specified period of time. Unfortunately, this definition becomes very ambiguous as soon as product quality starts changing, and new products are introduced. The government tries to use “hedonics” to adjust for quality changes, but in truth there is no solid theoretical support for their attempts. It’s all a big mess.
What does it mean to say that product X is 47% higher quality than product Y? Does it make you 47% happier? Perhaps at a moment in time you could compare what people will pay for each product in the marketplace, at least if their sales overlap somewhat. For instance, how much more were people willing to pay for fancy HDTVs, compared to the old boxy sets, while they were still being offered? But this method doesn’t really work, because the early adopters of the new technology tend to be rich, with a much higher willingness to pay than the average person. There’s no shortcut, they really have to figure out how much better something is, and no one has ever defined “better” adequately.
Economists tend to ground everything in utility theory. So one fairly standard approach is to ask how much someone living today would have to earn to achieve the same level of utility as a person making $100,000 back in 1964. The US government seems to think the answer is $600,000. But the actual number could just as well be $100,000 or $1,500,000. It’s not a clearly defined question. Consider the following two ways of thinking about inflation.
1. Here’s one thought experiment. Get a department store catalog from today, and compare it to a catalog from 1964. (I recently saw Don Boudreaux do something similar at a conference.) Almost any millennial would rather shop out of the modern catalog, even with the same nominal amount of money to spend. Of course that’s just goods; there is also services, which have risen much faster in price. OK, so ask a millennial whether they’d rather live today on $100,000/year, or back in 1964 with the same nominal income. Recall the rotary phones and bulky cameras. The cars that rusted out frequently. Cars that you couldn’t count on to start on a cold morning. I recall getting cavities filled in 1964, without Novocaine. Not fun. No internet. Crappy TVs, where you have to constantly move the rabbit ears on top to get a decent picture. Lame black and white sitcoms, with 3 channels to choose from. Shorter life expectancy, even for the affluent. No Thai restaurants, sushi places or Starbucks. It’s steak and potatoes. Now against all that is the fact that someone making $100,000/year in 1964 was pretty rich, so your social standing was much higher than that income today. So it’s a close call, maybe living standards have risen for people making $100,000/year, maybe not. Zero inflation in the past 50 years may not be right, but it’s a reasonable estimate for a millennial, grounded in utility theory. In which period does $100,000 buy more happiness? We don’t know.
2. Now let’s make the exact opposite argument, that all nominal income gains since 1964 have been pure inflation. In this view the government has grossly understated the inflation rate. It’s actually a pretty easy case to make. Start with the fact that surveys seem to suggest that Americans are not significantly happier than in 1964. Then consider that people’s happiness may depend on how well they do relative to expectations, or compared to their neighbor. Utility is a social construct. People are embedded in society, and judge their situation relative to others. The guy with a color TV in 1964 felt on top of the world, ahead of his neighbors. Now that sort of set would be so junky that it would be out at the curb. Someone on welfare could pick it up and take it home for free. But they’d feel miserable, wondering why they had to end up with such a junky TV. So if your income rises at the same rate as the rest of society, you feel neither more nor less happy.
One reason these two thought experiments lead to such radically different conclusions is that we are not holding other things constant in the same way. Do we consider a case where only the individual in question sees a big nominal pay increase? Or where everyone does? It makes a big difference.
The public and media think of the “cost of living” in a much different way from economists and bureaucrats at the BLS. Here’s an article entitled “Basic Costs Squeeze Families” in the WSJ:
Spending on mobile-phone service, meanwhile, has soared, rising nearly 50% since 2007, the year the iPhone came out and data plans became more commonplace.
In Kansas City, Mo., Dawn Miller said her family’s cellphone bill has grown from $35 a month years ago to more than $350 some months today, depending on whether someone in the family blows past their plan’s monthly data limit.
“Because the Verizon bill is so expensive, and because it changes month to month, you have to cut back,” said Ms. Miller, a police dispatcher.
Two months ago, she and her husband postponed an anniversary dinner after their Verizon bill eclipsed $500. “I can’t tell you the last time I went out to a movie,” she said.
Similarly, spending on home Internet service has soared by more than 80%. Last year, it made up about 0.8% of spending for middle income households, up from 0.4% six years earlier. Despite talk of “cord cutting,” spending on cable and satellite television is still up 24% from 2007.
The article suggests that inflation might be higher than official government estimates. But they also define the concept differently, more like the increasing cost of “the way we live now.” But if we use that definition then inflation will always equal the growth rate of nominal income, and real income will never rise. As we earn more, we buy more, and our “cost of living the way we live now” will go up.
In contrast to inflation, NGDP growth is a very useful concept for studying business cycles, financial crises, the deadweight cost of taxation, lender/borrower unfairness after nominal shocks, and lots of other purposes.
PS. I’m not trying to criticize the actual government estimates. I have no problem with the claim that prices have risen 6-fold since 1964 and RGDP/person is up 150%; it’s no worse than any other number pulled out of thin air by the BLS. My point is that these numbers aren’t worth arguing about. There is no right answer, and inflation is not a useful concept.
Update: Did King Louis the 16th of France (who was probably the richest person in the late 1700s) have a lower or higher living standard than an average American today? It depends on what you value. If you have a big ego, and like to live in a big house and be surrounded by people who flatter you, then you’d say he had a higher living standard. But he only lived 38 years (not untypical of that period) and lacked cell phones, TV, films, jet trips to exotic locales, Japanese and Thai restaurants, the internet, fast cars, etc. In some ways his life was quite monotonous. You can probably tell which life I’d prefer. On the other hand, if you read Thomas Piketty you might come to the conclusion that he’d make the opposite choice. 🙂
However, I don’t think antibiotics would have saved Louis XVI’s life . . .
Dec 7 2014 at 10:15am
People care a lot about their absolute level of comfort but they also care a lot about their relative standard of comfort. That’s just human nature.
I agree with almost all of this post but I don’t think we should conclude that that, just because something is impossible to quantify, that it’s “not a useful concept.” By that standard, many things we do, and should, care about a lot would not be useful concepts.
Probably this most objective standard of inflation is how many hours of work for the average worker it takes to purchase some product that has not changed a lot in quality. But people will tend to perceive that there has been inflation any time they feel their economic situation has worsened relative to their previous situation.
Dec 7 2014 at 10:37am
The difficulties with measurement are well known, but it’s quite extreme and I would even say irresponsible to proclaim that any attempt at measurement is meaningless. Piketty seems to assume that inequality should be an argument in a social utility function, and you seem to accept this as a justified position. Whatever happened to Arrow’s impossibility theorem? Are North Koreans doing ok, because it’s meaningless to claim that they could be better off? Should we, as many environmentalists do, accept any reduction economic output as a good thing because it saves the planet, as opposed to the rat race of keeping up with the Joneses? These are the sorts of things we debate about. If this debate is meaningless, what is meaningful?
Dec 7 2014 at 11:00am
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Dec 7 2014 at 11:30am
Inflation is a fairly useful concept over the short-term, but I think Scott is correct that the long-term inflation where the basket of goods & services is hardly comparable is pretty meaningless.
This is especially true because you can’t compare even those goods that haven’t changed because the importance to our lives of those goods have changed.
Dec 7 2014 at 12:04pm
Greg, You said:
“But people will tend to perceive that there has been inflation any time they feel their economic situation has worsened relative to their previous situation.”
That’s the problem, it would imply there was more “inflation” in the Great Depression, than the 1970s.
Alex, I agree that in extreme cases, like the German hyperinflation, or comparing living standards in North and South Korea, there will be enough general agreement among observers to say something about real living standards. But the debates you see in the US don’t fall into those categories.
That’s why I’d prefer we focus on NGDP growth, as our nominal indicator.
Tom, You said:
“Inflation is a fairly useful concept over the short-term”
Useful for what purpose? I can’t think of any use for which there aren’t better variables, such as NGDP.
Dec 7 2014 at 12:11pm
The question is sensitive to scaling. Ask about $3,000/year and almost anyone, millennial or not, who thinks about it will choose 1964.
Dec 7 2014 at 12:12pm
Gee, it’s almost as if there’s another definition of inflation out there that’s more useful…
Another issue is that products don’t get uniformly “better.” Take, for instance, the fact that a 64 oz container of orange juice is now 59.4 oz; or that bacon is now sold in 12 and 10 oz packages, which I had never seen a kid. Is this some giant conspiracy by food manufacturers to rip us off, or perhaps just two examples of producer prices rising nominally and the difference being passed on to consumers? Sure, there can be a bad orange crop, or a pork blight, or the government can force pig food into our car engines…
These are just two examples off the top of my head (and written at breakfast time! which reminds me of the 10 oz cereal boxes we have now…). But sticking with food for a moment, you’ll also notice that food prices would have skyrocketed if, like the reduction in size, a reduction in quality hadn’t been taking place over the years. The processed foods of today should cost pennies w/o inflation; instead their prices have remained relatively stable, while real food prices are reflected somewhat by the “organic” brands.
I think that the concept of inflation gets destroyed when you try to combine it with things like “cost of living.” Those are different concepts, and if the American public gets confused then we have American economists obsessed with nominals and apologizing for State intervention in the money supply to thank for that. The State has its own reasons to obfuscate and confuse the understanding of inflation; some academics do, too, but usually the ones who have some reason to want to be in the good graces of the Fed, or to some day make policy for it.
Since the State is paying its obligations through inflation (SS benefits, soldier pensions/healthcare, etc.) it would rather that inflation mean something along the lines of what Dr. Sumner is discussing now, viz, cost of living or quality of life. The goal is to be able to say that horse meat is hamburger is steak, there’s been no inflation (and thus no repudiation of its debts), and we’ve always been at war with Eurasia.
Inflation is not confusing when you use the actual definition and don’t step through the looking glass of State manipulation. Hedonics indeed!
Patrick R. Sullivan
Dec 7 2014 at 12:20pm
It isn’t just inflation, most statistical constructs have to be used with extreme caution. Something an awful lot of economists don’t seem to appreciate. Think about all the supposedly competent people claiming to have ‘proved’ that raising the minimum wage doesn’t have disemployment effects. Just for one example, that is.
Also (since they’re being featured in TV commercials now) two of the richest people ever in America, John and Horace Dodge–without whom the Ford Motor Co. wouldn’t have gotten off the ground–both died in 1920, in their fifties.
Dec 7 2014 at 12:42pm
I think some people sort of have in mind that inflation is the difference between making $100,000 in today’s dollars versus making $600,000. Which is crazy.
Dec 7 2014 at 12:58pm
We can certainly agree that the perceptions of the man in the street are not a reliable way to measure inflation. But whatever highly imperfect technical methods of measurement are used should yield some useful information if they are consistently applied.
Would you object to me claiming that Milton Friedman put both the concept and the measurement of inflation to good productive use? Would you object to me claiming that there was significantly more inflation in America in the 70’s than there was in the 60’s or 80’s?
If I understand you correctly (and please correct me if I don’t) NGDP is the sum of some constantly changing mix of real growth and inflation. The selling point for NGDP targeting is that it should provide a reliably counter-cyclical monetary policy without having to solve the inflation measurement problem at all.
If that is a fair description, then the concept (but not the measurement) of inflation is doing some important theoretical work there.
Dec 7 2014 at 1:35pm
I forgot to mention in my earlier comment that inflation, if understood correctly (that is, an increase in the money supply), doesn’t even have to mean/result in rising prices. That’s not what inflation is, and that seems to be why Dr. Sumner is confused.
Inflation, when the State printing press is to blame, is distribution of wealth. When the State inflates prices may remain the same or even fall! (depending on productivity changes) But the beneficiaries of the new money have purchasing power distributed to them.
“Cost of living,” and Dr. Sumner’s critique in general, is a different conversation about a different phenomenon.
Dec 7 2014 at 1:47pm
-I agree with you on the extreme cases. Brazil, for example, had (officially) negative RGDP per capita growth in the 1980s despite extremely strong NGDP per capita growth. But what about third-world countries? Did RGDP per capita in Senegal, for example, really hardly change between 1960 and today? Did that in Madagascar steadily decline?
It’s certainly possible. Madagascar has changed much less than China or South Korea over the past few decades. Certainly there must be some grain of truth behind these inflation measurements. But I’m still not sure what a survey of Malagasys would reveal about whether they’d prefer to live in the Madagascar of 1960 or today.
Dec 7 2014 at 2:19pm
If you compare the prices of things that haven’t changed much either in quality or demand (haircuts and Cheerios?) maybe you get a better sense of change?
The larger “are you better off” question is pretty self-evident. Way!
Dec 7 2014 at 2:32pm
Well put, regarding the frightful definitional and measurement problems with inflation. There is incredible political pressure to manage and manipulate this figure, along with GDP itself. I’m amazed that we still perform erroneous apples-and-oranges arithmetic with rates of interest and rates of inflation.
It is handy that NGDP skips this mess in some part. But I still have some reservations:
1. What happens to NGDP and monetary policy when we redefine GDP to include estimates of black market activity such as prostitution and drug trade, per Italy’s example? Domestic housework?
2. Why 5%? Why not 2%? Why not 0%? Why not 15%?
3. Does NGDP drive growth or is that causally backwards? Might the cart overrun the poor horse?
4. Cantillon effects from monetary expansion.
5. Who gets all the new money? Might degrees-of-separation-from-the-money-fountain explain lopsided incomes distribution? Even if the huge monetary expansion of the last 6 years hasn’t leaked from reserve accounts into the greater economy, wouldn’t a gigantic reserve balance make firms more powerful and influential than otherwise?
If there is a link between feeding at the money trough and inequality, I would look at firms first, explaining individual income inequality as a secondary effect.
Dec 7 2014 at 3:39pm
Greg, No, inflation is not a useful part of business cycle models. Use NGDP and employment.
trent, No, “inflation” does not mean an increase in the money supply.
Larry, No, the price of unchanging goods like oil is not a useful measure of inflation.
Rick, Answering those questions would take a long time, I recommend googling my Mercatus paper on the case for NGDP targeting.
Cantillon effects are not important.
Dec 7 2014 at 4:16pm
If the reason we’re asking these questions is to form practically useful policy (as opposed to musing philosophically) I think the conclusions are:
– The Happy City: happiness for social we animals through human scale urbanism. Role of state is mostly not subsidising crap or mandating parking minima, unnecessary use separation etc. but also nuisance/pollution managment and some coordination (build-to lines, good neighborliness).
– Technological innovation (which seems to be the bulk of your millennial’s material desires, as opposed to just more of the old stuff) where the govt role is mostly get out the way. IP reform maybe. Goal-less R&D maybe (to invent internets, NASA-velcro and the like).
Dec 7 2014 at 4:19pm
Sumner’s glib response to Trent pretty much gives the game away to my mind. Inflation absolutely used to mean an increase in the money supply and it isn’t particularily clear to me why Trent can’t insisnt on the old definition. Especially since consensus econcomics concedes that in the long term the biggest contributor to inflation is the printing press.
But mainly its symptomatic of the substitutionary impulse that has overtaken the analysis of inflation. In the same way that a new definition was substituted for the old one a less expensive item can be subbed in in a pinch to replace a item under inflationary pressure.
At the point where the breadbasket of items for the index can shifted around you no longer have a scientic index. You can say the new inflation metric is a helpful sociological tool to understand costs of living, but you are no longer scientifically trying to gauge inflation. Inflation studies are purely an activist attempt to demonstrate that inflation is not occurring. Scientifically, substituting in items under inflationary pressure into rather than out of the metric is just as valid. Doing so I could easily produce a breadbasket that demonstrated double digit inflation.
Dec 7 2014 at 4:34pm
Well said, Scott. Perhaps more succinctly: there is no theoretical basis for an objective method of determining “the” price level. There are as many price levels as there are prices (actually more, many more-combinatorics and all that).
Even so, I found argument two a lot weaker than argument one. Probably because I doubt one can compare survey results on happiness meaningfully across generations.
That being said, I would take care to distinguish between a measure of nominal transactions volume as useful for understanding business cycles, and Q as a (very crude) measure of economic “goodness” over the long term. Whatever use NGDP has in other respects, a higher level of NGDP is not automatically economic “goodness” nor is it a necessary condition for increasing economic “goodness.”
Not to suggest you don’t agree, it’s just something I would have emphasized more.
Dec 7 2014 at 4:56pm
Scott – How you can be both such a radical skeptic of the measurement of utility and a utilitarian?
Dec 7 2014 at 7:31pm
I said “another definition of inflation out there that’s more useful” [emphasis added]. I would direct you to the numerous sources that use that definition, but you know them already. That is why people say “price inflation,” which would be completely redundant if it were the definition of “inflation” that everyone used. And isn’t the point of your post to fix the ambiguity around the word, and to understand how it might be useful? You seem fiercely committed to being willfully ignorant; I believe that it is because it is deeply immoral to inflate in the classic sense (which I’ve used), and you’re committed to inflation as a matter of social policy. So I understand your reticence to engage in a conversation that takes the standard historical definition as its basis.
@Sam Haysom, thank you for noticing. It’s true, pretty much the only thing inflation (read: wealth distribution by the State) advocates do when confronted with this line of thinking is to try to snarkily and smugly ignore it and, if possible, slide in an insult to the questioner. To do otherwise would invite some uncomfortable soul searching.
There is a great article by Robert Higgs that follows along with my thinking that most PhD economists are not really economists, but instead “Policy Engineers” who are at best decent mathematicians skilled in using high-powered algebra.
For the most part macroeconomists suffer from a delusion that they can control the economy if only given the chance, when in fact it’s hugely complex and the variables have minds of their own. “Policy Engineers” don’t understand or admit the complexity, and have no moral compunction treating the variables (men) as pawns, and assuming they have no motivations of their own. It’s sad. I love this blog, but as you said, his glibness gives away the game. Macro divorced from Micro is kind of a joke, but the people telling it have no sense of humor.
Dec 7 2014 at 8:04pm
I suggest, for the sake of argument and countering semantic evasion, to simply refer to monetary expansion.
Totally sidestep the debate over the meaning of inflation or tight / loose. The tendency which confounds economic calculation is that of monetary expansion.
Dec 7 2014 at 8:21pm
I can definitely appreciate that, but like Dr. Dan Klein’s mission to reclaim the word “liberal,” I feel that language is too important to just throw in the towel. Especially given the topic at hand.
The science, and especially as it’s absorbed by the layperson, loses when we concede the meaning of commonly understood words to those who would change them for their own ends. Think about why the definition of inflation would have been changed over time; qui bono? Inflationistas who would distribute earned purchasing power to their favorites during periods of productivity gains when the inflation wouldn’t lead to rising prices; and Policy Engineers of the State who don’t want the cognitive dissonance of trying to believe on the one hand that they are helping everyone by helping the economy when in fact they understand their place as the court apologists for said immoral and anti-economic distribution. (I’m also saying “distribution” instead of “redistribution” because wealth is earned/created by men, but taken and distributed by the State; it was never initially distributed to later be redistributed.)
But again, I definitely can appreciate your point, and thanks for taking the time to reply to me. It’s unfortunate that you to have to spend time thinking up ways we can hinder such “semantic evasion” in the future.
Dec 7 2014 at 8:54pm
This post came off as kind of an indictment of the coherence of utilitarianism.
Dec 8 2014 at 6:07am
There must be some pleasure in passionately doing useless things like insisting on THE definition of a term. A better tack would be to make a case for the definition, like what Sumner is trying to do for NGDP as a metric for demand.
Dec 8 2014 at 8:23am
I think inflation is a useful idea that everyone needs to consider. It’s entirely true that you can come up with a theory of inflation that’s robust (in theory!) with regards to change in the quality of a good, and even change in the relative demand at a societal level for a good, and that incorporates all the sociological effects of it.
The problem is, as ever, that econometrics cannot properly measure it, because you will never disentangle all the effects described in the article from actual changes in price. I agree with Scott Sumner that inflation is great in theory but useless as a business cycle theory indicator.
Dec 8 2014 at 9:49am
How on earth do you have a scientific, or any, conversation without knowing the definition of a term? Or specifically, “THE” definition of a term? And what would happen if Dr. Sumner made a successful case for a term? We would have a definition, correct. Would you then pop into the thread to deride anyone who tried to use that definition of the term.
In fact, what do you mean by “definition”? Or “term”? Or “the”? Does it depend on what the definition of “is” is? I’m curious.
Dec 8 2014 at 10:18am
“trent, No, ‘inflation’ does not mean an increase in the money supply.”
Do you realize that for almost the entire history of the word (in reference to economic phenomena) it has actually had that exact definition? And that if the definition hadn’t been under attack you would not be confused at all, and your blog post would be largely irrelevant?
I think you were quite rude in dismissing me thus. I can point you to dozens of dictionary entries that defined the word exactly as I did. I can’t believe you don’t know that, so I must believe that you were being intentionally rude and dismissive.
Given that your blog post was about exactly this, that is, the usefulness of the concept of inflation, I am frankly shocked that you would dismiss my point so brusquely.
Dec 8 2014 at 11:23am
An excellent article and I can agree with almost any of this. However there is one thing that puzzles me – if inflation is useless then so are some other concepts like productivity growth, real interest rates etc. And yet somehow people find those things useful in practical scenarios such as assembling their investment portfolios.
Imagine that tomorrow FED adopts 5% NGDP targeting and you are asked this question – is there any minimal safe nominal interest rate that you would take compared to any other investment alternative?
I can imagine some very skilled microeconomist giving you series of questions establishing how you value risk or what is your time preference. In the end we would probably end up with some variable that is similar to “expected inflation” (whatever it is), real interest rate etc.
So I guess my point is that while inflation may not be what some people – including those at BLS – think. However it is far from “useless” concept.
Dec 8 2014 at 1:12pm
Does individual debt statistics give more insight concerning the inflation estimate. Are people borrowing more to maintain a relative standard of living?
Dec 8 2014 at 1:32pm
If what the Professor says true, and it sounds plausible to me, how can one compute the “real” return on any asset, stocks, bonds, etc? Does it therefore render the concept of “real return” meaningless? What does one substitute in its place?
Dec 8 2014 at 2:28pm
Very good article and points out how we economists make assumptions without digging deep into what we mean by a term like inflation. By the way, notwithstanding your dig at Pikkety, Scott- he does have an interesting discussion on inflation as well- Remember where he too talks about the limits of measuring it.
I would rather have this piece called,
Why debates over inflation are pointless (when it is relatively low, and technological change is high, over long periods of time).
Note in many countries, times and places this has not been the case. Particularly- your argument hinges on technological change. Go to many countries in Africa, and inflation matters much where there has been little change in lifestyle over the past 100 years. Price spikes and commodity price changes have quite an effect.
Dec 8 2014 at 4:16pm
Did King Louis the 16th of France (who was probably the richest person in the late 1700s) have a lower or higher living standard than an average American today? It depends on what you value.
It does depend on what you value. Of course, not everyone values cell phones or jetliner trips to exotic locales either. Personally, I would love to have a huge house, because of the sorts of things that having a huge house enables you to do (throw extravagant parties for your friends, have the entire family over for christmas, without any of them having to rent hotel rooms, have music room, a solarium, workshops for hobbies, a kitchen with lots of counter space, a jacuzzi bathtub, a dry sauna, etc.) I’m not really sure that cell phones and TV make up for that.
Dec 8 2014 at 6:51pm
Chiming in to support trent steele. Yes, inflation is nowadays most frequently the result of monetary expansion and its principal effect is the transfer of purchasing power from those who own money to those who issue it. There are situations where brief inflation is triggered by other mechanisms and of course there are many methodological difficulties in measuring this phenomenon but clearly Dr Sumner’s dismissal of this notion is unwarranted.
Dec 8 2014 at 9:03pm
“Whatever use NGDP has in other respects, a higher level of NGDP is not automatically economic “goodness” nor is it a necessary condition for increasing economic “goodness.””
This is true. I would go you one further and say that NGDP has no real meaning in and of itself. (Consider Zimbabwe). To me, that lack of real meaning is precisely why is a reasonable monetary policy target.
On the other hand, changes in the path of NGDP are a useful indication of whether the monetary system is interfering with real exchange. That’s true in a recession (where the fall in nominal income makes it hard to exchange real goods/services for money) and at the other extreme in a hyperinflation (where you get paid and immediately go to the store and buy whatever is there because, well, at least you get something real for your money even if it isn’t what you want).
Dec 8 2014 at 9:40pm
The “would you rather live now or back-in-the-day” question is kind of loaded. Personally, I would rather live today than in the past even if there were some futuristic utopia society in the past.
It’s cus there’s this underlying attitude that the past doesn’t matter because it’s already been done and it’s more important to focus on how we go forward from here.
You could pose the question going the other way and ask if I’d rather live in a dystopian future where everything was 1920’s tier-tech. Honestly I am not sure, because the future seems so much more relevant than the past.
Dec 9 2014 at 1:13am
@trent steele: “Given that your blog post was about exactly this, that is, the usefulness of the concept of inflation”
No, Sumner’s blog post was about whether the concept of price inflation was useful in explaining macroeconomics, or even whether it was well defined. Your response was that you preferred the label “inflation” to refer to monetary expansion instead. Your response was not relevant to the subject of the blog post.
The term “inflation” is already well understood — both inside and outside of economics — to be referring to a rise in the price level, not a mere expansion of the money supply. Sumner says that people are mistaken in their intuition that “a rise in the price level” is well defined. (Or whether it is useful, even if it could be defined, given that you can study NGDP instead.) You respond that the label “inflation” could be well defined, if you give it a different definition. So what? The important point is the surprising claim that “a rise in the price level” is not well defined, and you haven’t said anything relevant to that point.
Dec 9 2014 at 1:23am
@Rafal Smigrodzki: “Chiming in to support trent steele. Yes, inflation is nowadays most frequently the result of monetary expansion”
You “support” steele? Do you realize that he wishes the term “inflation” to be defined as “monetary expansion”? So it couldn’t possibly be “the result of” such expansion. Do you really understand what you claim to be supporting?
Dec 9 2014 at 3:27am
Even if we accept the proposition by trent steele, that inflation is defined as a rise in the money supply, isn’t that a useless metric?
If inflation is defined as an increase in the money supply, and if inflation (the money supply) changes without real things like the amount one can consume or the amount one can produce changing, isn’t that a useless metric?
Moreover, measuring the supply of money, like measuring changes in prices, is very difficult to do, especially if you broaden the idea of the supply of money to include things that go into M2 and M3.
Defining inflation as change in money stock doesn’t seem to me to be any more obviously useful of an indicator than a change in price level is. In fact, while both change in price level and change in money supply are hard to measure, one can argue only change in price level is a very useful thing to have on hand.
Dec 9 2014 at 4:00am
@ Don Geddis
Re-read the post. Sumner says “inflation,” not “price inflation.” And the title of the post is “Why debates over inflation are pointless.”
Then you criticize me for saying “Given that [his] blog post was about exactly this, that is, the usefulness of the concept of inflation…” by stating, “No, Sumner’s blog post was about whether the concept of price inflation was useful in explaining macroeconomics, or even whether it was well defined,” immediately after which you criticize me for talking about the definition of inflation!
On top of all of that, you’re taking only one line from only one of my posts and curiously disregarding the rest.
So while I will answer you quite clearly, I won’t do so until you’ve demonstrated that you’ve read and comprehended the relevant material more carefully.
@ Don Geddis @ A re: Rafal Smigrodzki
We understand what he means, and the fact that it’s at all unclear is a good argument for why we do need to have a strictly observed, agreed upon, and unchanging vocabulary for economic science to function well.
Also, thanks Rafal, I appreciate your comment.
Dec 9 2014 at 4:03am
Trent Steel has not provided an argument to support. He is simply making a pointless assertion that there is a “THE” definition. That is tautology, not reasoning. Rather than standing behind a semantic commitment, share the underlying logic. THAT would actually be valuable.
The triviality of this assertion based commentary is particularly apparent in light of Sumner’s argument that you can’t judge the stance of monetary policy from a discrete monetary base figure. Fine, so the people who support Trent Steele’s identity disagree, or hold an implicit model of the relationship between recent changes in the base and anticipated base changes. Or something else. Lose the semantics, and provide the logic.
Dec 9 2014 at 9:07am
Sam, You said:
“Sumner’s glib response to Trent pretty much gives the game away to my mind. Inflation absolutely used to mean an increase in the money supply and it isn’t particularily clear to me why Trent can’t insist on the old definition.”
This is a myth I hear all the time. Inflation has been used in many ways over time; increases in prices, increases in the money supply, and reductions in the gold content of a currency are three very different one’s that come to mind. The accepted definition today is an increase in prices. Check any econ textbook. Try going around calling people “gay” in the sense of the old meaning, and see what luck you have. Then report back to me.
Andrew, On the second point I could have added that I make 10 times what I used to make, but don’t feel any happier.
Jason, Yes, it’s a huge problem, but all the alternatives are even worse.
Trent, On inflation, see my reply to Sam. I would add that not only is your definition not useful, it is extremely harmful as it causes confusion and wastes people’s time. Like my time is being wasted right now discussing definitions instead of important issues.
“For the most part macroeconomists suffer from a delusion that they can control the economy if only given the chance, when in fact it’s hugely complex and the variables have minds of their own.”
If that remark is directed at me then you don’t seem aware of the fact that I am a libertarian who opposes government attempts to control the economy.
You seem very angry. I suggest you start acting more gay, in the original definition of the term. 🙂
JV, Perhaps I should say that once you consider NGDP growth, the value added of inflation is zero. Obviously if inflation is all you have, it tells you SOMETHING. But there are better variables out there, which makes it useless in my view.
Dec 9 2014 at 9:33am
Inflation is a useful concept, and some of the indices, like the CPI, are useful ways to measure it. If that were not so, we wouldn’t see contracts with wages or retirement benefits tied to the CPI.
Scott, you seem to be implicitly arguing that we should do away with the CPI and other such indices. If so, what do you suggest people who are trying to protect their pensions do instead of indexing to the CPI?
Dec 9 2014 at 1:05pm
@ Dr. Sumner
This will count for @ Don Geddis et al as well.
Dr. Sumner’s point is essentially that “inflation” is meaningless, or at least so hard to define as to be useless; or so hard to agree on due to measurement difficulties that it seems ill-fitted for the things it’s used for (by the State) like its “debts” (e.g., SS) or its “monetary policy”/economic finagling.
First let’s dispel the notion that I’m using some obscure, irrelevant, or worse, imaginary definition. Here. Now, that obscure institution that knows a thing or two about inflating says that “[i]nflation is the process of making addition to currencies not based on a commensurate increase in the production of goods” (Federal Reserve Bulletin (1919)).
Okay, so if that’s the case, then we have a new problem, viz, how do “we” measure increases in the production of goods, so that “we” don’t “inflate”? Well, now we start to run into some measurement problems (which, even if we had the means, would of course still be subject to all of the standard Public Choice problems, but I digress)! Alas, it’s almost as though a few dozen, or hundred, or thousand, or million, macroeconomists and econometricians aren’t up to the task, as evidenced by Dr. Sumner’s post. No one can agree, it’s constantly changing, subject to all sorts of different assumptions, based on ridiculous utilitarian nonsense like hedonics, chaining, etc. I think the one thing everyone in the thread agrees on is that it’s a mess!
Here is why my points are relevant and important: If we understood what inflation was, and we all used the same and commonly understood definition (before it was gradually changed for “reasons”), and we internalized Dr. Sumner’s blog post (and Smith’s, Hayek’s, Higgs’, and many other obscure economists’ insights about the impossibility of “knowing” the economy or the “price level” or “GDP”) then “we” might realize that it’s criminally absurd to put the Fed/State in charge of our money; that we need sound money; that these problems Dr. Sumner is complaining of are red herrings.
If money was private and voluntary then all actors using money would be monitoring the economy, its growth, its prices and products; and the money supply would naturally expand and contract along with the needs of the economy. Would it be “perfect”? Of course not, silly! But is that what we’re comparing it to? No, we’re comparing it to the things Man is capable of on earth this side of Nirvana. So in that sense it’s the best we’ve got or are ever going to get.
Now the word you’ve been waiting for: Gold. Of course, it doesn’t have to be gold. But thousands of years of human history make me feel like I’m on pretty firm ground suggesting it. It could be something else, of course. But gold works for many reasons, among which is the fact that when its relative value rises people dig more up, and when it falls they wear it or put it into computers and such. And no Fed Policy Engineer has to tell them.
So there we see Dr. Sumner’s objections to the shoddy and useless “definitions” of inflation fade away like some green piece of paper left out in the elements. And we solve his problems. No more “monetary policy” (which, being merely nominal, achieves nothing w/out deception of the economy’s actors); no more ripping off creditors with “chained CPI,” hedonics, and horse meat! And as a bonus, no more talented people like Dr. Sumner spending valuable hours working on pointless algebra, and no more interested but misguided commenters wasting their valuable time tilting at “tautologies.”
So the correct definition of inflation yields us not only understanding, but shows us that Dr. Sumner’s “problems” are not problems of the economy or of definition, but of the State monopolizing money.
To sum up: the definition is important, and if we agree on it and internalize it we see that Dr. Sumner’s problem evaporates. What he has actually identified is not that it’s pointless to have debates over inflation because of “cost of living” or other nonsense; it’s pointless because no one should be in charge of inflating! Money will take care of itself better than we can take care of it, and we should leave it alone.
As for the word “gay.” If the shifting definition ever gives intellectual cover to the manipulation of the entire economy, I will be there to set everyone straight.
Dec 9 2014 at 1:21pm
@ Dr. Sumner
If that remark is directed at me then you don’t seem aware of the fact that I am a libertarian who opposes government attempts to control the economy.
NGDP targeting, and everything that goes into calculating it, and using it, is not libertarian. You know that. If I were to point out why then I would be wasting both our time.
You seem very angry. I suggest you start acting more gay, in the original definition of the term. 🙂
I am unbelievably gay! :)) I’m sad if it doesn’t come through in my writing.
Also, it’s not about acting gay, it’s about feeling and being gay! Many who act gay are actually just putting on a face to the world, and are, privately… not gay. We should do our best to find these people and bring as much gayness to their worlds as possible. 😉
Dec 10 2014 at 4:20pm
@trent steele: “If … we all used the same … definition … then “we” might realize that it’s criminally absurd to put the Fed/State in charge of our money; that we need sound money;”
LOL. That’s not how it works. Even if we were to agree to your preferred definition of the term “inflation”, all that does is clearly label a concept for the purposes of communication. It has no policy implications. Definitions are never claims about the real world. They are not “right” or “wrong”, or “true” or “false”; they are only either useful, or not. All your arguments over terminology have put you no closer to convincing anyone about the wisdom of having the government issue fiat currency.
If you want to argue for a policy, then you should do that directly. Your arguments here about a mere definition are a complete distraction, irrelevant to any policy decision.
Dec 10 2014 at 6:02pm
Dear Sir, I’m very sorry but you’ve missed the point of my comments and have for some reason gotten stuck on the very first point.
I would love to hear your criticism of the substance of my points which merely begin with the notion that we should use clear and agreed upon definitions when we are talking about science.
I go on to show how this definitional problem has led Dr. Sumner astray, and how the actual problems he identifies in his post are easy to solve once we do… and then follow the economic logic from there.
Dec 11 2014 at 3:06am
‘The question is sensitive to scaling. Ask about $3,000/year and almost anyone, millennial or not, who thinks about it will choose 1964.’
But of course that’s an impossible scenario — virtually no one lives on $3K a year in 2014 because available government assistance is more than that.
Dec 11 2014 at 3:15am
gold…But thousands of years of human history make me feel like I’m on pretty firm ground suggesting it.
For nearly all of that time mankind had much, much lower living standards than today. Looking at just the last few hundred years, it’s obvious that the gold standard leads to economic instability because banks cannot guarantee liquidity without fiat currency. That’s why the pre-fiat era is characterized by periodic panics that lead to mass bankruptcies and wild swings in employment and production (just look at a graph of YOY industrial production changes).
Dec 11 2014 at 2:29pm
If you take out the world’s two greatest depressions, the Industrial Revolution, and America’s history up to the early 1900’s, then yes, I agree with your post.
Dec 11 2014 at 2:52pm
I’d agree that inflation is pointless from this viewpoint. However, inflation has a firmer basis in information theory than utilitarianism.
Inflation appears to be the difference between how much information could theoretically be moved around with money (proportional to M^k) and how much information is observed to be moved around (proportional to measured NGDP).
Lorenzo from Oz
Dec 11 2014 at 5:46pm
For those pushing inflation = expansion of the money supply, if inflation = expansion of the money supply, what do we call it if the money supply expands and the price level falls?
And does anyone think that, when folk talk about deflation, they mean “contraction of the money supply” and not falling price level? Even in, say, 1890?
Would anyone care about monetary expansion if it had no effect on the price level?
If “velocity” (average rate of use in transactions in a given time period) is utterly stable, then an expansion of the money supply would automatically mean rising prices, for a given level of output. But it demonstrably is not always stable.
When historians write of the “Price Revolution” aka Great Inflation of the late C15th to early C17th, they mean the continuing upward movement in prices in the European economy. Whether it was caused by monetary expansion has been hotly disputed. (I think it obviously was, from the fivefold increase in Central European silver mines, to the looting of the Inca/Aztec empires to the Potosi and other silver mines.)
As far as I can see, the inflation = monetary expansion nonsense exists only to preserve the Austrian theory that the Great Depression was “caused” by the 1920s boom and has absolutely nothing else to recommend it.
Dec 11 2014 at 6:42pm
@Lorenzo from Oz
…what do we call it if the money supply expands and the price level falls?
If you read the post these comments refer to, I think you’ll see that the concept of a “price level” is utterly bogus. Things have prices. They rise and fall for many reasons. Aggregates of things have an aggregated price, and the reasons that aggregate number might rise or fall are myriad (money supply effects, productivity effects, changing tastes, obsolescence of some old products and appearance of other new products, etc.). In fact, that is essentially what Dr. Sumner is arguing against: the concept of the “price level”! He gets hung up because the word “inflation” is inappropriate, and that is my entire point. The word “inflation” would be pretty useless if it meant “changes in an aggregate statistic that is meaningless due to” the reasons stated in Dr. Sumner’s post. Everyone is confused, including the good Dr., because he is talking about measuring the “price level,” not measuring inflation.
Would anyone care about monetary expansion if it had no effect on the price level?
Absolutely. And this is one of my points. Improperly understood (see Sumner, Geddis, A, et al), you’re right: no one would care! Properly understood, rising productivity could mean that even with inflation there might be no rise in the “price level” (of course, I’ve said all this in this thread, but why not one more time for the people in the back), yet the inflation would benefit those who receive the new money first by redistributing purchasing power to them.
A (very) simple thought experiment: There are N people and X “dollars” in the economy when productivity doubles. Prices would fall, yes? But if the money stock was doubled then, simply, the “price level” would remain the same. But if all of the new money went to only one person, that person would have had purchasing power redistributed to him. Now, if you have problems with this thought experiment, before you reply, realize that your problem(s) will stem from the concept of the “price level,” not the definition of inflation.
“Price Revolution” and “Great Inflation” are two different things (which is why they are made up of different words), though they could easily be related, and could be two terms relating to the same period and general set of phenomena. Calling something “The Great Wet Period” and also “The Great Rainy Period” could be because rain makes things wet, yes? As you said, it’s possible to have prices rise, fall, or stay the same given inflation, deflation, or a static money supply. So I’m not sure that you meant to bolster my point, but thank you.
As far as I can see…
Given your caveat it is unnecessary for me to respond to this.
Dec 11 2014 at 6:48pm
Your comment/working paper look interesting, and I agree that money/prices are information in a sense, but I honestly do not have time to read deeply enough into it to respond to you. I think we agree that utilitarianism is shaky ground, to say the least. Based on this post I think most (even the author?) agree.
Dec 16 2014 at 10:08am
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