A column in the Wall Street Journal implicitly reminds us of the strange theories of inflation that are lying around. Inflation seems to be conceived as the mysterious increase of some prices that must be caused by some people who selfishly demand more units of “aggregate output” (a sort of dark matter) for themselves. If these people are bad capitalists, the increase is called “greedflation”; bad workers, and we speak of “wageflation.” Strangely, this mysterious somethingflation is never called “rulerflation,” perhaps out of respect for the leaders of mankind. (See Greg Ip, “As Greedflation Starts to Fade, Wageflation Creeps In,” Wall Street Journal, July 6, 2023.)
Recently, the ridiculous idea circulated that Beyoncé’s concert in Stockholm had accelerated inflation in Sweden—“beyoncinflation,” we should call it. If some stones became more expensive, would it be useful to call the phenomenon “stoneflation”? (See “The Beyoncé Effect: Sweden’s Inflation Feels the Hit,” Wall Street Journal, June 14, 2023; “Beyoncé Blamed for Stubbornly High Swedish Inflation,” Financial Times, June 14, 2023.)
Without claiming any originality, I propose another way to look at inflation. Its advantage is to have its roots in the economic way of looking at things, to be consistent with the analytical tools of economics—even if the ultimate theory of inflation one may build on that foundation may be more complex.
Suppose a constant stock of money, whether it is made of gold or any sort of paper or anything that people generally consider to be a convenient medium of exchange. Now, some selfish individuals think they will improve their individual welfare by consuming more of good or service B. (You may think “B like in Beyoncé show,” but it can be any other produced good or service.) They must of course consume less of some good A. The reason is that resources are scarce. To produce more B, the economy must produce less A (along its production possibility frontier or PPF). Being bid up, the relative price of B increases, which is the same as saying that the relative price of A decreases. Alternatively, we can say that, on the PPF, the opportunity cost of B increases and the opportunity cost of A decreases. Of course, the remuneration (wages or profits) of the producers of A diminishes, and the remuneration of B’s producers increases. Nobody can speak of inflation. There seems to be no badflation! Why?
I suggest that we can’t rationally think about inflation without first answering this question.
READER COMMENTS
Craig
Jul 7 2023 at 4:21pm
“If we turn to the cause of the disease, the first and most important, thing to be said is that
inflation is produced by government. I do not mean that it produced out of ill-will or malice. It is produced by government because government responds to the wishes of its constituency.
However, every government, whether it be in South Africa or in any other country of the world which embarks on an inflationary course, is quick to blame other people for inflation. You will discover, if you listen to Governmental officials, that inflation has been produced perhaps by the Arab sheiks, perhaps by the greedy businessmen, perhaps by the grasping trade-unionists in countries where they have power, perhaps by the spendthrift consumers. ” – Milton Friedman
The government will take responsibility for many things, inflation will never be one of them.
Thomas Hutcheson
Jul 7 2023 at 5:54pm
The root cause is a generational effort, so far successful, by the Fed to duck responsibility for both inflation and unemployment, the two things that Congress explicitly tasked them to manage.
Jose Pablo
Jul 8 2023 at 8:33am
The root cause is a significant bias against corporations among voters and media consumers.
Politicians and journalists just follow the incentives.
Within this biased framework corporations (or wealthy individuals, which are about the same on voters and media consumer’s eyes) are guilty of almost everything:
Climate change is big corporations’ responsibility (what about the individuals voluntarily consuming products and services?)
Inflation is big corporations’ responsibility (what about individual level of consumption driving up prices? … you cannot charge a higher price to an individual unwilling to pay for it)
Nuclear power is not a solution to climate change because it is controlled by big corporations (solar a wind power not … or it used to not be controlled by big corporations … now that they are, “voters and media consumers” oppose them more and more
Within this framework the Fed effort to duck responsibility is mainly irrelevant. Most voters and media consumers, don’t even know what the FED is or does. But they do know that big corporations are evil. Voters and media consumers of all creeds do agree on that.
Craig
Jul 8 2023 at 11:56am
“duck responsibility”
There are people today who actually are saying, “Look, it was transitory after all!”
Thomas Hutcheson
Jul 8 2023 at 12:19pm
A factor. But have YOU never heard of greedy workers/unions blamed for inflation? How well understood is it that the Fed was responsible for the glacially slow recovery from the 2008 financial crisis? Did Bernanke apologize for that? Did Powell apologize for the inflation of 2021 – ? Will he tear his garments if there is a recession on his watch?
Craig
Jul 8 2023 at 5:16pm
“How well understood is it that the Fed was responsible for the glacially slow recovery from the 2008 financial crisis?”
As QE in response to the pandemic was ongoing many people feared pending inflation and as inflation began to rise a debate emerged between those who believed QE was responsible for it and those who felt inflation rising would be transitory. At the time one of the arguments put forth by the transitory school is that the Fed had obviously engaged in QE during the GFC but obviously inflation like that experienced most recently simply did not happen. So naturally that requires an explanation, ie why did QE not cause inflation during 2008 but cause inflation during the post pandemic period?
The most compelling answer I heard was offered by Professor Steve Hanke, who actually opined that notwithstanding the QE during the GFC that the money supply didn’t increase fast enough to cause inflation because the commercial banks weren’t lending. Just following up on your original question now, Professor Hanke is of the opinion that Bernanke’s QE likely saved the US from a worse downturn because, in his opinion, in accordance with the monetarist perspective, the money supply would’ve dropped and the downturn would have been more severe.
Thomas Hutcheson
Jul 9 2023 at 2:49pm
I think that is right. QE (somewhat offset by IOR) was not “whatever it takes” to achieve the target. I think the reason for this Fed mistake is still not understood.
Jose Pablo
Jul 9 2023 at 11:12am
Don’t get me wrong Thomas. I agree that inflation, being a monetary phenomenon, is, always and everywhere, the resposibility of those in charge of setting monetary policy.
My point is that this reality is not convenient to journalists and politicians since most readers and voters have no clue of what the FED is or does.
Being this the case, you don’t need the FED ducking anything for having journalists and politicians blaming inflation on their favorite cause of the day. This is just “incentives at work”
Thomas L Hutcheson
Jul 9 2023 at 3:09pm
Yes, but one can still ask why? Why wouldn’t a politician want to blame the Fed for inflation? I actually think it would have been smart politics of Biden to have just always “expressed confidence” that the Fed would, “consistent with its Congressional mandate” [double duck!] handle inflation in the best interests of the country 🙂 He could still have “understood” that Putin and supply chain problems were making the Fed’s job harder and even claimed that his Administration was helping make the Fed’s job easier by X, Y, and Z.
And nothing stands in the way of Chairman Powell saying that, yep, back in 2021 we were a little slow in starting to try to reduce inflation. The latter, BTW, is a serious idea of Scott Sumner that the Fed formally do self evaluations of its past actions. I agree.
David Seltzer
Jul 7 2023 at 6:25pm
If per Milton Friedman, “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” How did Beyonce cause inflation? Did all those concert goers have printing presses that produced enough Krona so as to decrease buying power? Only governments have those Gutenberg inventions. But I could be wrong.
Craig
Jul 7 2023 at 10:32pm
The Professor once advised me that one of the problems with measuring inflation, ie the general price level, is that the methodology uses a basket of relative price changes. Reading the article it said the concert tour in the country was such that it contributed ‘.2’ to inflation and there is some ambiguity to that figure as I read it (maybe I need to reread it), but ultimately perhaps its such a small country that concert goers from others spend enough money there that the impact gets measured?
Pierre Lemieux
Jul 7 2023 at 11:59pm
Craig: The claim, as I understand it, is that Beyoncé attracted so many people from the rest of Sweden and from foreign countries that the prices of tourist accommodation in Stockholm, mainly hotel rooms, shot through the roof, fueling inflation. For the Swedes, demanding more hotel rooms because of Beyoncé meant that they had to demand less of other things; they pushed the economy along the PPF, causing a change of relative prices.
To the extent that it was foreigners who bid up the prices of hotels, it is true that the new money supply could conceivably have caused a one-shot (tiny) increase in the rate of measured inflation, but the adjustment would have more likely been (at least partially) through the increase in the price of the krona on foreign exchange markets, which would have led to a decrease in the demand for, and production of, Swedish exports. The increase in Swedish imports would have also helped cool off the one-shot increase in the general price level. Same general result as before: more of B (and imports), less of A (and exports).
Craig
Jul 8 2023 at 11:53am
Craig: “but ultimately perhaps its such a small country that concert goers from others [other countries] spend”
Sorry I didn’t write that correctly.
Professor: “so many people from the rest of Sweden and from foreign countries”
Mentally I focused on people entering Sweden because thinking about it I thought that people from the rest of Sweden would spend money on concert events and incidentals, but as a result wouldn’t spend that money going out to eat in their hometown or spend it elsewhere on other things?
Pierre Lemieux
Jul 8 2023 at 4:42pm
Craig: Yes to your last question. You were correct to raise the issue of foreigners attracted to Beyoncé’s concert in Stockholm and pushing up prices after changing their domestic currencies (or euros) into kronors. My answer was meant to show that this would likely have little effect on inflation due to adjustment on foreign exchange markets. These foreigners’ increased demand, and bidding up prices, for Swedish hotel rooms (for example) was compensated by foreigners buying fewer exports from Sweden, also a movement on the Swedish PPF.
All these effects on the Swedish economy would, I suspect, have been very small anyway.
Thomas L Hutcheson
Jul 9 2023 at 2:43pm
It seems quite plausible that a discrete demand shock to one sector could show up as a blip in a price index. And if (unlikely in the case of hotel accommodations/restaurant meals) it were to a sector in which prices do not readjust downward when the demand shock has passed, it would require the central bank to allow a bit more inflation to permit re-establishment of full employment equilibrium than w/o the shock.
That is what the F in FAIT is supposed to mean.
Pierre Lemieux
Jul 12 2023 at 11:06am
Thomas: Isn’t it “FAITH”?
Pierre Lemieux
Jul 12 2023 at 11:13am
Thomas: In Vol. 1 of his Law, Legislation, and Liberty, Friedrich Hayek proposes some iconoclastic ideas on flexible, expedient policies. In a way, he completes these ideas with his reference to Pashukanis in Vol. 2. It does require some rethinking of Pigou-style or Keynes-style divine government.
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