This post was inspired by a recent Tyler Cowen post, entitled “I’m not so worried about inflation”. The post itself is fine and I’m not going to comment on it. Instead, it was the title that sparked my interest. What might a person mean when they say they are not so worried about inflation? I can think of at least 5 distinct meanings:
1. The speaker might be saying that they simply don’t view 4% or 5% inflation as a problem, even if were to occur. Some economists hold this view, as higher prices feed back into higher nominal incomes. They might believe that this would get us out of a liquidity trap.
2. Or they might mean that while high inflation is often indicative of a policy failure, other measures like NGDP growth are more informative. (That’s my view, and also the view of economists like George Selgin and David Beckworth.)
3. Or they might mean that while high inflation is usually a problem, they currently don’t expect it to occur. (That’s what Tyler meant.)
4. Or they might mean that they are becoming less concerned about inflation being too low, coming in below the Fed’s 2% target. An economist might be likely to look at things this way, as within the economics profession there is a tacit assumption that excessively low inflation has been the bigger problem in recent years. You’d be more likely to see this interpretation in the Financial Times than in USA Today.
5. Or they might view below 2% inflation and above 2% inflation as being equally bad, and this statement might be expressing confidence that inflation will average right around 2%. A Fed chair might be expressing this view.
In one sense this post is merely about the ambiguity of language. But there’s more at stake than just terminology. Some of these differences reflect different worldviews, with important causal implications. Back in 2010, Ben Bernanke expressed frustration that below 2% inflation is not widely viewed as a problem. His comments gave the impression that confusion about the purpose of inflation targeting made the Fed’s job more difficult.
Inflation is not like crime, pollution, epidemics, and other societal problems. In those cases, the reasons why the public worries about the problem are almost exactly the same as the reasons why policymakers worry about the problem.
That’s not at all the case with inflation. The public thinks inflation is bad because as shoppers they don’t like paying higher prices for goods and services. Policymakers believe that view is wrong; higher prices do not directly reduce aggregate living standards. One person’s expenditure is another person’s income. Rather, excessively high inflation, excessively low inflation, and/or excessively unstable inflation may reduce living standards in all sorts of indirect ways, such as discouraging saving and investment, creating financial market instability, or interacting with sticky wages to create unemployment.
During WWII, the public was almost completely supportive of the US military as it tried to defeat Germany and Japan. The Fed does not have such strong support from the public or Congress, and thus its job is more difficult.
In the mid-1970s, Gerald Ford said, “Whip inflation now“. That’s a much more accessible slogan than, “Maintain a symmetrical 2% core PCE inflation target, averaged out over a decade”. As an analogy, in 1942, “Beat the Huns” was a more accessible slogan than is, “Maintain the appropriate balance of power in the Middle East” or “Find the right mix of engagement and conflict with China” in the year 2020. As the straightforward problems get solved, we are left with the more complex problems.
PS. Isn’t that sort of like life? The simple “Find a boyfriend” of age 17 gets replaced by, “Balance the needs of children, husband, parents and in-laws at age 43. Sigh . . .
READER COMMENTS
Henri Hein
Dec 18 2020 at 2:13pm
Isn’t there an assymetry problem, in that retail prices would shoot up fast, but wages would take a while to adjust to the new inflation? In that situation, the public really do lose out in the short term.
Scott Sumner
Dec 19 2020 at 1:09pm
There may be distributional effects for unanticipated inflation, but it’s not clear that the public loses out. Unanticipated inflation from expansionary monetary policy tends to raise real incomes, as in 1965-68, and “the public” did extremely well during those years.
Inflation from an adverse supply shock hurts, but that’s because the supply shock reduces real income, not because of the inflation.
Mark Z
Dec 18 2020 at 3:43pm
I don’t think 2 and 3 are entirely inconsistent. One may want the Fed to achieve modestly higher than 2% inflation (in accord with keeping NGDP stable when RGDP is low), and also believe that we don’t need to worry about really high inflation – which many pundits are still anticipating – because velocity is down. I think there’s a big overlap between people who believe both 2 and 3, and people who say they’re not worried about inflation more or less mean both.
I though about it, and I don’t think I could state the basic case for NGDP targeting (inasmuch as I understand it) in fewer than 4 sentences, so I think pithy slogans are out of the question unfortunately. “Grease those sticky wages now!” Eh.
Scott Sumner
Dec 19 2020 at 1:11pm
I agree that people can view more than one claim as correct. Nonetheless, these are distinct arguments.
robc
Dec 18 2020 at 4:32pm
The problem with that isnt just that it is complex, but that said balance probably doesnt exist. We shouldn’t even be trying to solve that problem.
Feel free to apply the same reasoning to the Fed.
Scott Sumner
Dec 19 2020 at 1:12pm
I agree about the Middle East. I also believe that we should not be trying to balance inflation and unemployment, which is why I favor NGDP targeting.
robc
Dec 21 2020 at 10:24am
You have convinced me that NGDP targeting is the best approach in a fiat money system.
I still don’t think fiat money is a good idea. I would prefer private money, preferably backed, and a non-existent Fed.
Nicholas Decker
Dec 19 2020 at 2:39am
Maybe a bit kooky, I dunno, but does the actual rate of inflation actually matter, so long as it is constant? Whether it is two percent or three percent or four or fifty – if people are completely able to predict where the inflation rate is going to be in the future (the same) wouldn’t that mean that the negative effect of inflation – people being discouraged from saving and investing because of uncertainty over future interest rates – be eliminated? I have heard the possibility that it would increase menu costs, but I doubt it – it would be completely plannable and automated, and we’d expect no more costs than what you should already be doing figuring out the cost of inputs and what the market is willing to buy at. Moreover, it shouldn’t interact negatively with wages – employers and employees can perfectly anticipate what the inflation rate will be and schedule automatic pay increases. I could see the argument of wages and prices rising out of sync – that is, wages maybe have an annual or biannual hike but prices rising continuously, leading to sudden spikes in purchasing power, causing cash flow crises. Of course, the best way to manage a cash flow problem is cheap and easy credit, so there you go. This is probably a bit of kookery, but I don’t see the problem with any given inflation rate, so long as it is predictable. Would someone please enlighten me as to where I am wrong?
Alan Goldhammer
Dec 19 2020 at 9:29am
It may matter to someone who is retired and on a fixed income that is not adjusted for inflation. The pension I received from my employer was fixed at the time of retirement (2010) and is not adjusted for inflation going forward. It might also matter to non-unionized employees who might not be able to bargain for pay raises to keep up with inflation. Right to work states make it harder for workers.
Scott Sumner
Dec 19 2020 at 1:16pm
It would slightly matter for menu costs. Even if predictable, it’s more costly to adjust menus every week, vs. once a year. If we don’t index our tax system it punishes savers (that’s the biggest cost of anticipated inflation in the US). It hurts holders of currency. That might actually be good, as lots of currency is held for tax evasion purposes, or even crime.
But yes, for low rates of inflation, say 2% vs. 3%, it matters very little as long as it’s predictable.
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