Matt Yglesias has a post entitled:
Trump would make inflation worse
I have a slightly different view. I’d make the following two claims:
1. Trump would not make inflation worse.
2. Trump would make “inflation” worse.
That obviously calls for an explanation.
Economists define inflation as the percentage change in the price level. Alternatively, it can be viewed as the percentage decrease in the purchasing power of a dollar. When the dollar loses purchasing power, the price of goods, services, and labor goes up. By itself, this has no real implications. It’s kind of like a two for one stock split—just an accounting change. (And no, inflation is not the change in the money supply.)
In our textbooks, we justify the widespread concern about inflation by pointing to various subtle “costs of inflation”:
1. People visit ATMs more frequently, to avoid holding lots of currency that is losing purchasing power.
2. Restaurants have to redo menus more frequently.
3. People are less likely to save because our tax system taxes the nominal return on capital.
But this is not why the average person cares about inflation. If you ask people, they won’t say:
“More trips to the ATM” or “costs of changing menus” or “deadweight cost of taxation of nominal capital income.”
They’ll say, “Duh, obviously inflation’s bad because you have to pay more for stuff, and that lowers your standard of living.”
But that’s wrong. Inflation doesn’t directly hurt consumers, as a pure inflation causes incomes to rise as fast as prices. Wages are also a “price”.
It’s true that there are cases where incomes don’t rise as fast as prices, and in those cases people are hurt. But then the thing that is hurting them is not inflation; it’s the thing that causes incomes to rise by less than inflation. It might be the thing that reduces real GDP—some sort of real problem like a crop failure or an oil embargo. Some people can also be hurt by redistribution of income from one group to another. But in all of those cases it’s not really the inflation that hurting people, it’s the falling real GDP or the redistribution of income from one subgroup to another.
The Fed is targeting inflation at 2%. Right now it’s above 2%, but the markets seem to expect it to fall to close to 2% in a few years. I don’t believe Trump being elected would change that fact. Hence:
1. Trump would not make inflation worse.
However, Trump might well worsen the things that people actually care about when they say they care about inflation. Yglesias mentions examples such as Trump’s promise to sharply raise tariffs on imports. I believe that this would make most American feel worse off. But not because the CPI would begin rising at faster than 2%, rather because the Fed would be forced to depress non-import prices in order to maintain its 2% inflation target. In that sense, Trump’s policies might cause “inflation” in the way that the public wrongly conceives of the term. That is:
2. Trump would make “inflation” worse.
You might say I agree with the bulk of Yglesias’s post, while not being on board with the post title. Yglesias also mentions immigration and residential zoning as areas where Trump’s views differ from those of traditional Republican supply-siders. And although Trump has promised to pay off the entire national debt in his second term, his actual tax and spending proposals suggest a big increase in the budget deficit. This could further raise real interest rates, hurting investment. In fairness, Trump would probably also do some tax and regulatory changes that would boost GDP growth, so the net effect of his policies is uncertain. Yglesias’s post assumes a second Trump term would be more “populist” than his first term, as he’d fill his administration with true believers, not traditional Republican officials recommended by people like Mike Pence.
I have no idea how things would actually play out.
If you wish to argue that Trump would increase inflation, in the sense that economists define inflation, the strongest argument is that the budget imbalance would become even more severe (and it’s already gotten much worse in the past few years), and that this would trigger “fiscal dominance” over monetary policy. I still think we are far from fiscal dominance, but in the very long run it’s a concern if the budget situation is not addressed.
PS. To follow up on a recent post, there are already rumors that Javier Milei is backing away from his dollarization pledge—but nothing I’ve seen is definitive.
PPS. See if this helps:
1. Trump would not make inflation worse. (cost of living)
2. Trump would make “inflation” worse. (standard of living)
READER COMMENTS
Gordon
Nov 24 2023 at 5:42pm
But what about the fear of some economists that Trump could take control of the government in such a way that there are no checks on his power? Much like when he was in the White House previously, he’s currently railing against high interest rates as he sees ultra low interest rates as a good thing (much like Turkey’s Erdogan did a few years ago – and we saw what happened there). What if he replaces the Federal Reserve board with loyalists who will carry out his low interest rate policy? And Trump is very adverse to admitting a mistake. If a low interest rate policy did send inflation soaring, would he reverse course? Or would he stick to his position much like the way he has with other things?
Jon Murphy
Nov 24 2023 at 7:11pm
That’d be quite impossible. The Board are elected to staggered 14 year terms. Only 1 will be up for reappointment during a potential term, and even then not until 2026.
Besides, the Fed doesn’t set rates. Even if there was some coup and all were replaced, the banks would still behave in their best interest.
vince
Nov 24 2023 at 8:36pm
TDS overpowers considerations of impossibility.
Jon Murphy
Nov 25 2023 at 9:28am
Indeed it does. In both directions, too
Richard Fulmer
Nov 24 2023 at 5:54pm
There is also the possibility that Trump’s policies could so lower foreign confidence in the U.S. that people and governments dump U.S. government securities.
john hare
Nov 24 2023 at 7:25pm
And although Trump has promised to pay off the entire national debt in his second term,
A statement like that should disqualify one for public office. Very basic math.
Matthias
Nov 24 2023 at 8:44pm
How is that a basic math mistake?
In principle, it’s entirely possible to pay off the national debt.
Eg he could sell off assets, like Alaska, to pay for it. Or he could give the debts to the individual states, there by eliminating the ‘national’ debt.
Or the economy could pick up so drastically that the tax take would increase to make paying off the debt easy.
The latter is unlikely, but that’s an economic judgement of reality, not a pure math thing.
Ahmed Fares
Nov 24 2023 at 10:56pm
Richard Fulmer
Nov 25 2023 at 3:23am
Assuming Professor Wray’s facts are correct, the connection between retiring the nation’s debt and recession could be deflation. Before we abandoned the gold standard, repayments to foreign governments would mean specie taxed out of the economy and sent overseas.
Richard Fulmer
Nov 25 2023 at 11:58am
On the other hand, depressions – especially international depressions – are unlikely to be the result of a single cause. Many other factors were involved in each of the downturns Wray lists:
1819 – The War of 1812, which ended in 1815 and which was largely financed by printing money.
1837 – The end of the Second Bank of the United States in 1936. Inflation triggered by the Specie Circular executive order issued by President Andrew Jackson in 1836.
1857 – The sinking of SS Central America, which was transporting gold to New York banks. British PM Palmerston’s circumvention of the requirements of the Bank Charter Act 1844. The failure of Ohio Life Insurance and Trust Company.
1873 – The Franco-Prussian War (1870-71). Inflation in the United States. The demonetization of silver in the U.S. and Germany. Like the depression of 1857, this depression was international and was unlikely to have been caused by the U.S. government’s debt payments.
1893 – A gold run on the U.S. Treasury by foreign investors alarmed by American overseas speculative investment failures. The collapse of wheat prices in 1893. Over-investment in railroads.
1929 – The Smoot-Hawley Tariffs, which triggered a global trade war. A nearly 50% increase in the U.S. money supply during the 1920s, much of which ended up in the stock market. The flow of gold from Great Britain and other countries to France, which did not issue more currency in response.
Jim Glass
Nov 25 2023 at 9:44pm
(1) The last (only) nation to explicitly endorse and adopt Professor Wray’s Modern Monetary Theory as policy was Sri Lanka, which thereafter went bankrupt. (How is that even possible for a nation with a fiat currency?)
(2) Who in the world is seriously talking about “retiring the nation’s debt”? Few enough — far too few — are seriously talking about its ongoing explosion. Trump certainly isn’t serious about it, that was just him grabbing his daily dose of narcissistic supply. Are the Trumpistas really dim enough to take such absurd blather from him seriously?
Scott Sumner
Nov 25 2023 at 12:37pm
Wray is confusing cause and effect.
Richard Fulmer
Nov 25 2023 at 2:06pm
Interesting. Please explain.
Scott Sumner
Nov 26 2023 at 1:38pm
During the 1800s, it was normal to run surpluses during good times. When we go into a depression the budget swings into deficit. But the surpluses that preceded the depression don’t cause the depression, rather the depression causes the end of budget surpluses.
Jim Glass
Nov 25 2023 at 10:15pm
I’ve seen this banal observation trotted out for 20+ years now and have never understood how so many could consider it some sort of keen insight. Yes, people die after maybe 60 years of adulthood, so it is difficult for them to personally accumulate debt for 190 years. Duh. (Though if one considers “households” like the Rockefellers (since the 1870s), Mellons (since the 1850s) , Busches (since the 1840s), du Ponts (since shortly after the American Revolution), and a good number of others, one might become a bit less strident about this point).
But here is one way the government’s budget is just like a household budget: Each has to pay annual borrowing cost on the debt it accumulates. Borrow too much, and the interest cost hurts.
BS
Nov 27 2023 at 2:10pm
Not so much the length of time, as the fact that accounts tend to be settled after a person’s death. Countries don’t (often) “die”.
Andrew_FL
Nov 24 2023 at 9:46pm
Where do these “pure” inflations happen, besides on a blackboard?
Scott Sumner
Nov 25 2023 at 12:41pm
In the real world. Other stuff happens, but don’t attribute the effects of the other stuff to inflation. Were the 1960s “hard times”? Do shoppers suffer when prices rise 5% and wages rise by 7%?
The worst economic times are actually associated with deflation (1921, early 1930s, 1938, 2009, etc.)
Andrew_FL
Nov 25 2023 at 4:16pm
Real wages have not in fact risen but fallen over the last three years. Certainly people with fixed nominal wage contracts have seen their real incomes fall. But no, people must be wrong, inflation isn’t actually harming them, it’s some nebulous “other things”
Scott Sumner
Nov 26 2023 at 1:36pm
Real wages have risen over the past year. They fell in 2021-22 due to adverse supply shocks (Covid, Ukraine, etc.) Inflation was not the issue.
Thomas L Hutcheson
Nov 25 2023 at 7:43am
You don’t even mention two other, more important things. a) the cost of the increased difficulty people have of speculation about future relative prices when many decisions especially about investment turn on that. b) some prices are not easily adjusted upward so their relative price is distorted downward creating the same kind of inefficiency that the too high relative prices of things with downward sticky prices in the face of too little inflation.
And the whole discussion is ambiguous about whether he is talking about inflation, above target inflation, or unnecessarily over target inflation.
Scott Sumner
Nov 25 2023 at 12:43pm
No, it’s not ambiguous. He’s clearly talking about “unnecessarily over target inflation”
Thomas L Hutcheson
Nov 26 2023 at 7:11am
Thanks for the clarification. THAT indeed has the costs I pointed out.
Thomas L Hutcheson
Nov 25 2023 at 7:52am
I guess it’s also possible that Trump could do something to be a big enough negative supply shock (more trade or immigration restrictions?) to require the Fed to engineer temporarily above target inflation to deal with it. Although if he had a trifecta, he would probably do another deficit-increasing tax cut, it might not be a big enough shock to require any above target inflation.
Jeff
Nov 25 2023 at 8:33am
I think your number 3 is actually a big reason why people dislike inflation, though the average person will of course not say “deadweight cost of taxation of nominal capital income” because that is not in their vocabulary. But they might say “Why is the government so intent on making buying a big house, or several big houses, a dramatically better ‘savings’ vehicle than savings itself?” In the past, a major stated reason for reducing inflation was to allow households and businesses to focus on productivity enhancements rather than tax avoidance—I may be mistaken but I don’t hear policymakers talking about that as much anymore.
Another reason not stated here is that the average person is perhaps not quite as dumb as most economists think, and would be far more likely to poke holes in, and far less likely to accept, the economist’s preferred rationale for all of these costs, namely, that inflation is needed to counteract nominal wage rigidity. Maybe a younger worker would see wage cuts or layoffs as a valuable signal to get out of a dying industry. Maybe their own compensation is primarily in stock, profit-sharing, or commissions. Maybe they are in a workplace where they would even prefer that some of their less-productive colleagues be terminated rather than everyone’s compensation stealthily eroded. At the end of the day it requires a very specific frame of mind and set of assumptions to arrive at the conclusion that this peculiar sleight of hand aimed at the worker psyche will be of general benefit to society.
Scott Sumner
Nov 25 2023 at 12:47pm
“Another reason not stated here is that the average person is perhaps not quite as dumb as most economists think, and would be far more likely to poke holes in, and far less likely to accept, the economist’s preferred rationale for all of these costs, namely, that inflation is needed to counteract nominal wage rigidity.”
If the example that follows this sentence is to represent the average person, then I’d say it’s very unlikely they could successfully poke holes in the arguments of economists. Economists may well be wrong on this point, but almost certainly not for reasons the public might put forth.
vince
Nov 25 2023 at 2:16pm
If by pure inflation you mean that everyone’s income and assets rise at the same rate as inflation, sure, but that’s not what happens. Inflation creates winners and losers.
An important justification for a target inflation rate is that it helps employers cut employee wages by sleight of hand.
It’s always seemed perverse to me that the Fed goal of stable prices has been translated to mean a rate of inflation. By rule of 72, in 36 years, a dollar loses half it’s value. That’s not a stable value.
Jim Glass
Nov 25 2023 at 9:21pm
Yup, sometimes income rises even faster.
2020-2022: CPI +14.1%. Employee compensation, +15.9%
It’s the dangest thing. While over these years I’ve seen and heard people everywhere moaning about how they are losing so much to inflation, I haven’t heard even one single person anywhere say, “Hey, I’m ahead of inflation over the last few years!” Or even, “I’ve been doing fine staying even with inflation.”
It’s almost like people operate with some kind of “negativity bias” that makes them think things are always going worse for them (and the whole dang world) than they really are … and that there are a whole lot of self-interested players out there who exploit this and prey on it to make people falsely think things are even worse yet.
Go figure. So much for the Intelligent Design argument as to human beings.
Scott Sumner
Nov 25 2023 at 9:54pm
“An important justification for a target inflation rate is that it helps employers cut employee wages by sleight of hand.”
No, that’s not a justification for inflation.
vince
Nov 26 2023 at 12:56pm
This is from http://www.clevelandfed.org/center-for-inflation-research/inflation-101/why-does-the-fed-care-technical
Why doesn’t the Federal Reserve set an inflation target of 0 percent?
… Economists tend to focus on two benefits of having a small but positive amount of inflation in an economy. The first benefit of low, positive inflation is that it helps to buffer the economy from falling into deflation, which entails just as many problems as inflation, if not more.
The second benefit of a small amount of inflation is that it may improve labor market efficiency by reducing the employers’ need to lower workers’ nominal wages when economic conditions are weak. This is what is meant by a modest level of inflation serving to “grease the wheels” of the labor market by facilitating real wage cuts.
Scott Sumner
Nov 26 2023 at 1:31pm
They are saying that it allows employers to keep the real wage at equilibrium. I wouldn’t call that “slight of hand” wage cutting. If it is, it’s clearly a good thing.
vince
Nov 26 2023 at 5:39pm
OK, you wouldn’t call it sleight of hand, but it is, after all, meant to fool employees. Instead of an obvious nominal wage cut, they get a hidden real wage cut.
Jeff
Nov 28 2023 at 4:33am
I was thinking that it operates *either* by giving employers a right to cut real wages that they wouldn’t otherwise possess, eg, if they are bound to long-duration nominal wage contracts, or if they are in a jurisdiction where nominal wage cuts can lead to constructive termination lawsuits, *or* by simply making it psychologically easier or less awkward to effect a real wage cut via “sleight of hand.” I wasn’t meaning to suggest that the latter is necessarily bad, though people may have different levels of comfort with it as a sort of large-scale behavioral intervention (some economists seem very comfortable with it, eg https://www.frbsf.org/our-district/press/presidents-speeches/yellen-speeches/2007/september/implications-of-behavioral-economics-for-monetary-policy/).
Jeff
Nov 27 2023 at 7:46am
Sorry, it is certainly possible that my argument is rubbish, but it’s not entirely obvious to me. If inflation makes it easier for employers to keep the real wage at equilibrium, isn’t it at least possible if not probable that that comes at some cost in terms of reducing the strength of the signal it affords to labor? A 55 year old who is just hoping the ship holds together long enough for them to coast to a pension almost certainly would benefit from the psychological anesthetic of inflation under almost any circumstance. But isn’t it possible that a 25 year old, the same individual who might undertake the challenge of training for a more remunerative career in a different industry upon seeing layoffs and/or nominal wage cuts at their company, would likewise be lulled into complacency and staying put with a nominal pay gain, all for the same real wage cut? That is what I was advancing as a possible long-term cost of the degraded signaling afforded by inflation.
David S
Nov 25 2023 at 10:07am
Trump supporters, and many other Americans, are burdened by the following set of delusions:
-The next president should enact policies that reduce the prices of fuel, food, housing, and durable goods
-The next president should eliminate the federal deficit and national debt
-The next president should eliminate the trade deficit with all countries
-Wages should continue to increase, and the value of my house should also increase
Trump will campaign on these points vigorously (when he remembers) for the next 12 months and probably be elected because enough people will believe that he can do these things.
Jim Glass
Nov 25 2023 at 8:43pm
“Would Trump make inflation worse?”
The least of concerns regarding Trump.
Bobster
Nov 26 2023 at 6:39pm
Trump reforming the wasteful IRA would be a huge improvement to the deficit. Not to mention he would stop the regressive student debt bailouts.
Biden not extending the TCJA would make people much worse off.
I also expect the Fed picks to be better under trump. The fed fell behind the curve when Biden delayed in reappointing Powell.
Scott Sumner
Nov 27 2023 at 12:16pm
I also expect the Fed picks to be better under trump.”
Trump picked Powell to head the Fed, and then continually complained that Powell wasn’t being expansionary enough. Trump has implied that his second administration will feature far more populist appointees than his first administration. So . . .
Warren Platts
Nov 27 2023 at 2:05pm
Scott, Trump will make YOUR standard of living decline because of the increase in import prices. But wages for working class folks will go up disproportionately as a result of reshoring industry, thus increasing their standard of living.
BS
Nov 27 2023 at 2:15pm
And then there’s the class of people not employed, not pensioned under a defined benefit plan, and living off accumulated assets (savings). If whatever is causing inflation doesn’t also cause investment returns to rise, surely they are not part of the “rising prices, rising wages, rising (COLA) pensions” crowd.
Warren Platts
Nov 27 2023 at 2:23pm
Averages hide a multitude of sins…. (Especially when it comes to economics!)
vince
Nov 27 2023 at 4:15pm
Exactly, and also those pensioned under a plan that isn’t indexed. For most of 2010-2022 real interest rates on savings had been negative.
As Warren says, averages hide much. That’s a problem with focusing on aggregates.
Comments are closed.