My rational fear of inflation

by Doctor Science

Paul Krugman often wonders why the public and policymakers seem so deathly afraid of inflation. I don't know about policymakers, but I know why at least one member of the Regular Public (me) is afraid of it: because I don't *believe* in wages going up, but I sure believe in prices going up. This is possibly another post in which I will demonstrate that I don't understand economics.

In a multi-blog discussion about whether the Fed should open the inflation spigot a trifle, Mike Konczal at Rortybomb talked about

a wide refocusing of the mechanisms of our society towards the crucial obsession of oligarchs: wealth and income defense.

Paul Krugman says:

That has to be right. It doesn't necessarily take the form of pure cynicism; it's more a matter of the wealthy gravitating toward views of economic policy that make immediate sense in terms of their own interests, and politicians believing that only these views count as Serious because they're the views of wealthy people.

The context is a discussion about inflation -- Krugman describes the current situation as

So, terrible growth prospects; low inflation; oh, and low interest rates, with no sign of the bond vigilantes. Ordinary macroeconomic analysis tells you very clearly what we should be doing: fiscal expansion and monetary expansion by any means we can manage; in fact, the case for a higher inflation target pops right out of just about any model capable of producing the kind of mess we're in.

Konczal and Krugman agree that the Fed should be aiming toward a slight increase in inflation, largely because it means that the wealthy people and corporations who are currently sitting on cash reserves would have an incentive to move them into the economy.

I commented:

I'm sure you're correct in a macroeconomic sense that Inflation transfers real resources away from those whose income is money and towards other agents in the economy, and that it thus can be a way of getting wealth out of the hands of wealthy hoarders and into productive circulation.

But I think you are *radically* underestimating how much this prospect frightens regular (non-wealthy, non-economist) people, whose income comes in the form of money (wages) or money (SS and other retirement funds). We're *petrified* of inflation, and we're more petrified when, as now, our incomes have gone down (because so many of us are un- and under-employed).

Any talk of inflation, for us regular people, translates to making the little we've managed to hold on to worth even less. For us to be sanguine about even 3% inflation would require us to be sanguine about the prospect of wages and employment going up.

From your POV as an economically secure economist, this may translate to our fear of the lag time between when inflation starts to press on the wealthy and when they free up their resources. From my POV as a regular person, this fear is perfectly justified -- I assume the wealthy will resist, with all their great economic and political power, doing anything that reduces that power.

Part of the Inflation Series, by Dutch artist Esther Janssen.

Later, I added:

I have a lot of problem with the word & concept of "rentiers", here in particular, because there are two groups involved: one which is small and powerful, another which is very large and democratically powerful.

Retired and disabled people are on fixed or high-inertia incomes. There are enormous numbers of them, so they have a lot of votes. Absolutely everyone has someone in their family who is in this group, and their maintenance is a natural, pressing concern for all of us.

I don't know if these people count as "rentiers" to economists, but they certainly think like rentiers in many respects. They are extremely inflation-averse, for instance: not because they have assets, but because their incomes *always* trail inflation.

Steve Roth replied:

I don't have a good answer to it given the wage/price dispersion over the last three decades — their failure to move together as they "should" in economic theory. (The Fed stomping on the brakes every time wages go up certainly doesn't help…)

I replied:

the wage/price dispersion over the last three decades — their failure to move together as they "should" in economic theory.

And I'd say that, from the perspective of a Regular Person, that the W/P dispersion has felt like continual stagflation. Prices keep going up, but income never quite keeps up.

Paul Krugman keeps wondering why the specter of stagflation grips people so hard, and attributes it to a kind of nostalgia or backward-looking fear. I wonder if it ever *stopped*, really -- as all the productivity gains of the past 3-4 decades have been sucked up by the uppermost class, people in the lower half or two-thirds of the income distribution have been working harder and getting less. It *feels* like stagflation, even if it isn't really from an economist's POV.

How not to control stagflation: 'Colonel Smith grasping the hind legs of a stag', painting by an unknown artist (1640-80), at the Victoria and Albert. I wonder if this might illustrate the exploits of John Smith of Virginia. Did he ever claim to have captured a deer "by hand"? -- it certainly can be done, though traditionally it takes three days.

Comments

[lunaticllama]

People with debt are not afraid of inflation once they realize that what they owe will decrease in value. Moreover, what people are afraid of is not really inflation but of the return to the global food crisis situation that existed in the 2007-2008 and continued financial speculation in oil markets.

[wj]

Those with debt (at least debt with fixed interest rates) like inflation if their income after servicing that debt is going up at least as fast. That would be
a) governments with large debt. They can index taxes to inflation (especially if they have income bands for taxes which don't have to be raise to keep up),
b) government employees with large debts (assuming that their jobs are essentially guaranteed, as most seem to be),
c) anybody else whose debts are big enough, and income secure enough.

Anybody who has savings (not investments, but something more like a straight savings account) or a fixed pension, definitely going to be hurt by inflation. Likewise anybody who, like Dr. S, has a job, but figures that their pay will not keep up with inflation. Which, after all, is part of the reason for inflation: to adjust wages relative to prices, because having some wages not keep up is easier than getting those wages to go down in nominal terms. And someone with debt won't necessarily come out ahead of their expenses go up faster than their income, because their ability to pay for their debt can go down faster than the real value of the debt.

All of that, of course, ignores the impact ont he economy as a whole of having inflation. From what we have seen in the past, a little bit of inflation (say 1%-8%) lubricates the economy and does not do major damage. High inflation trashes the economy, and nobody comes out ahead. And deflation likewise trashes the economy, albeit not quite as fast -- altough anybody with debt to service and limited income could be hurt.

[Snarki, child of Loki]

The 70's stagflation was a formative experience for many people.

But in order for a wage/price spiral to get going again, there has to be some confidence that the demand for labor can be turned into increased wages.

Not so much, in this age of weak unions and rampant offshoring. Not since the 80's.

[Matt McIrvin]

As I've said before: people who remember the Great Depression are almost all dead, but people who remember the 1970s are very much alive and voting. So the fact that the current situation is more like the Great Depression than the 1970s doesn't really register.

And the thing that makes the fear of inflation punishing is that precisely it's being used as a reason to avoid any increase in wages. If you're afraid that wages will lag inflation, it makes no sense to want to hold wages down.

[bobbyp]

The chickens of our morally contemptible income/wealth distribution will come home to roost.

[Slartibartfast]

Ah, but then the foxes of [insert your favorite demonization here] will break in and rip them to shreds.

[hairshirthedonist]

Here's a quote from Bill Mitchell's blog:

The Quantity Theory of Money which in symbols is MV = PQ but means that the money stock times the turnover per period (V) is equal to the price level (P) times real output (Q). The mainstream assume that V is fixed (despite empirically it moving all over the place) and Q is always at full employment as a result of market adjustments.

Yes, in applying this theory they deny the existence of unemployment. The more reasonable mainstream economists (who probably have kids who cannot get a job at present) admit that short-run deviations in the predictions of the Quantity Theory of Money can occur but in the long-run all the frictions causing unemployment will disappear and the theory will apply.

In general, the Monetarists (the most recent group to revive the Quantity Theory of Money) claim that with V and Q fixed, then changes in M cause changes in P – which is the basic Monetarist claim that expanding the money supply is inflationary. They say that excess monetary growth creates a situation where too much money is chasing too few goods and the only adjustment that is possible is nominal (that is, inflation).

One of the contributions of Keynes was to show the Quantity Theory of Money could not be correct. He observed price level changes independent of monetary supply movements (and vice versa) which changed his own perception of the way the monetary system operated.

Further, with high rates of capacity and labour underutilisation at various times (including now) one can hardly seriously maintain the view that Q is fixed. There is always scope for real adjustments (that is, increasing output) to match nominal growth in aggregate demand. So if increased credit became available and borrowers used the deposits that were created by the loans to purchase goods and services, it is likely that firms with excess capacity will re[spond by increasing output rather than increasing prices.]

[hairshirthedonist]

I was a little pressed for time when I wrote that last comment, so here's a link to the post where I got that quote. I think he pumps these things out quickly, because there are often editing problems, thus my filling in some missing text at the end. (I'm pretty sure I got it right.)

[CCDG]

Also interesting, from Umair Haque Questioning The Dogma of The Church of Wall St:

Please note: I'm not suggesting that "finance doesn't matter". But I am suggesting that a purely deterministic, mechanistic, linear, equilibrating, almost-Platonic mindset where finance, like an idealized engine, is the single, sole, most vital, and irreplaceable source of the horsepower of prosperity--well, that might just be the single greatest mental barrier to human progress in the 21st century.

[hairshirthedonist]

I should add that the quote comes from a discussion of the predicted effects of quantitative easing rather than fiscal intervention, but the excerpt still applies, I think.

Quantitative easing does less than real fiscal intervention (i.e. actual spending), since it simply exchanges government bonds for bank reserves, both of which will just sit there unless demand gets money flowing again. But the quote still addresses the current slack in the economy that can be taken up by fiscal intervention before creating problematic inflation.

[Sebastian]

Krugman is suggesting that people shouldn't be particularly afraid of inflation right now because a huge number of them have an enormous amount of debt. People with large student loans, large mortgages, large car payments, or large non-credit card debt, shouldn't be afraid of inflation. Small amounts of inflation ease economic transitions as well, which is the main thing Krugman is focusing on and he sees that people with lots of debt (which is to say a very large percentage of the people in the US) shouldn't be threatened by that.

I'm pretty sure this thread isn't directly begging for another MMT debate, but if Dr. Science wants it, I guess thats fine. ;)

[russell]

The more reasonable mainstream economists (who probably have kids who cannot get a job at present) admit that short-run deviations in the predictions of the Quantity Theory of Money can occur but in the long-run all the frictions causing unemployment will disappear and the theory will apply.

Pangloss was an economist.

[hairshirthedonist]

I'm pretty sure this thread isn't directly begging for another MMT debate, but if Dr. Science wants it, I guess thats fine. ;)

There's really no nead to have an "MMT debate" to address the narrow point of inflationary pressures in our current economic environment. (I happened to come across that quote in reading today and thought of this post, rather than reading this post and running out to find an MMT quote as a response.)

Krugman's point is fine (if limited), assuming inflation did occur, provided that Dr. Sci's fears of wage inflation lagging price inflation didn't materialize. If wages and prices move in step, debtors would be happy. Fixed incomers not subject to wage inflation, maybe not so much.

[christian h.]

Very good post. Krugman and like-minded economists do indeed discuss inflation from the macro-economic perspective - when most ordinary people rightly view the question from how it impacts their daily lives. This becomes particularly clear whenever Krugman complains about the refusal of people to accept "core" inflation as what's important. Not to my daily life, it isn't.

[Slartibartfast]

Krugman is suggesting that people shouldn't be particularly afraid of inflation right now because a huge number of them have an enormous amount of debt.

This may be the case, but there's a rather enormous number of people who are retired or near retirement that are definitely not looking forward to having their investments and/or nest egg devalued.

I happen to be one of those rare people who, at least at the present time, have a pension coming on retirement, and I'm uneager to see the value of my post-retirement pension payments begin to wane.

I know: my problem; not any one else's. Still, this one time, I am going to vote my wallet.

[Slartibartfast]

By "vote" I meant: expressing my preference. I don't think I will get much of a vote regarding whether inflation comes to visit.

[Daniel Rabiega]

Two points.

I'm reasonably sure that everyone who thinks we need higher inflation targets would also agree that fixed income sources such as those enjoyed be the retired should be indexed to increase with inflation.

Secondly, real wage decline and increases in the price level are separate. We've seen a lot of stagnant wages in the face in inflation, but it is the inflation that has allowed the wages to remain stagnant as opposed to decreasing. The decrease in real wages is tied to deeper inefficiencies in our society and while wages are slow to adjust downwards the pressures that keep wages stagnant in the face of inflation will actively lower them without it.

[elm]

It seems to me that the power dynamics that would/could cause wage growth to lag inflation exist independent of inflation.

That is to say that the economically mighty and politically influential will put the screws to you with or without inflation.

The mechanisms are different, of course. With low inflation, you will be robbed of your livelihood via unemployment, nominal benefit cuts, and sector-specific inflation (like medical costs).

A stagnant economy with lopsided distribution is a threat to your wellbeing with or without inflation.

[elm]

Slartibartfast:

I know: my problem; not any one else's. Still, this one time, I am going to vote my wallet.

The real question is whose wallet you're really voting to support.

A stagnating economy with continued high unemployment isn't good for investment returns.

I don't think anybody promotes inflation for its own sake; it's an instrument to increase employment.

[Aidan]

But Social Security is indexed to inflation...

[hairshirthedonist]

It's nice that some portion of some people's retirement is indexed to inflation, but SS and other inflation-indexed retirements are not the whole of retirement income in the US. And being indexed to inflation, broadly, does little to help people who, because of their circumstances, are particularly subject to specific, more narrow price increases that only marginally affect broader, perhaps even flawed, measures of inflation that drive such indexing.

That's not to say that any fiscal or monetary policy that involves an increase in inflation (or other more narrow price increases) is a nonstarter, just that certain effects on the population need to be acknowledged, considered and addressed. That's probably why people keep bringing them up.

[elm]

Also, I'm not saying that increased inflation is in my own interest or that it would necessarily increase employment.

I understand the economic argument involved (the expectation of higher inflation encourages consumption in the present), but the mechanism is indirect.

Direct expenditures operate via a more obvious and controllable mechanism and are a better solution to unemployment/underemployment.

Regardless, the emphasis belongs on jobs rather than on the mechanism (though known-ineffective mechanisms like supply-side tax cuts deserve to be laughed out of the discussion).

[johnw]

Stagflation involves a wage/price spiral while unemployment remains high. If wages don't spiral, you don't have stagflation. In fact, stagflation might be less painful than what we've got.

Inflation does do one thing very well, which is facilitate repricing things. The biggest problem we've got right now is the mortgage mess. If we had higher inflation, fewer mortgages would be underwater and more people could sell their homes. Of course, you can change prices by lowering them, but the practical effect as demonstrated in the mortgage mess is to trap many borrowers in a very bad position. Since the banks have successfully fought off any kind of cramdown on mortgages (unlike most debt) the only way to reprice the principal downward is to inflate the price of everything else.

[bobbyp]

Dear Doc,

If you are one of the "regular public" then you most likely have a job. Your wages probably go up more or less in line with inflation (but not productivity-another-and separate, issue). You probably own a house. You most likely own a few stocks in your IRA or other retirement vehicle(s). You undoubtedly have debt: Mortgage, student loan, credit cards, auto/appliance debt. The impact of inflation on your situation is undeniably mixed, but on the whole I would say it is positive. There are always "what ifs" or cases of special pleading (the poor widow living only on a fixed annuity from some rat-effing insurance company), or Slarti.

But really, if you're like many, your house is your main financial asset. Inflation works to boost its price and ease the pain of monthly payments. This is huge, but often overlooked.

On the other hand, deflation makes debt payment increasingly onerous the longer the deflation lasts. Your house appreciation is squat. Deflation does NOT guarantee everyday low prices, either. Further, deflation, due to sticky downward prices, puts most in a real bind as income decreases faster than the price level....this works both ways, ya' know ms. 'regular person'. In addition, deflation will (yes, this has been observed) increase the probability of widespread unemployment. This is bad for everybody. You might have noticed.

So which would you prefer? A mild case of 'inflation fever' and an upbeat economic future of increasing demand and employment, or deflation, lowered economic expectations, and a dismal economic outlook?

Your milage may vary, but on balance, I feel this view is more 'realistic' than that put forward by your 'regular person'.

As usual, when discussing economics, most people get it backward. Thus, I observe you are indeed quite ordinary in this regard. I have the same problem with thermodynamics.

[bobbyp]

Slarti: This may be the case, but there's a rather enormous number of people who are retired or near retirement that are definitely not looking forward to having their investments and/or nest egg devalued.

No evidence is presented to back this claim. Fully a third of retirees subsist solely on Social Security, a program indexed to inflation. Private pensions are on the wane, replaced by IRA's, etc. Presumably, a balanced portfolio of stocks/bonds will be, de minimus, inflation 'indexed'. You can also buy inflation indexed government bonds (TIPS). Furthermore, most people's main financial asset is their house. You might try asking around how a 20-30% drop in home prices impacted their equity as retirement looms. It's not a pretty picture. Many, dare I say "most" folks nearing retirement have seen their assets vaporized by the stock market crash of 2001 and the recent housing bubble collapse. And they still claim 'boomers' have made no sacrifices. Really.

Thank you Alan Greenspan, free market worshipping ideologues, the GOP, the business community, rent seeking 'too big to fail' bankers, and nutcase conservatism in general.

But by all means, vote 'your pocketbook'. That is called democracy. Your vote carries as much weight as anybody else's. That's the way it's supposed to work.

[bobbyp]

As usual, when discussing economics, most people get it backward. Thus, I observe you are indeed quite ordinary in this regard. I have the same problem with thermodynamics.

My apologies. Sometimes I get a bit snarky with the mantle of speaking for "ordinary folks". Well, that and the drink. Most of the time your stuff is great. This....not so much.

Carry on.

[Brett Bellmore]

"Fully a third of retirees subsist solely on Social Security, a program indexed to inflation."

Might actually be more accurate to say that the government's official 'inflation' numbers are indexed to what they think they can afford to pay people on Social Security...

[wj]

Daniel, allow me to suggest that you've missed something here. The only difference between inflation reducing real wages (by reducing the value of stagnant nominal wages) and simply cutting wages is that there is substantially more resistance to cutting nominal wages without inflation. Possibly because a cut in an individual's nominal wages in extremely visible.

Inflation is much more of a backgound noise phenomena. You notice prices keep getting higher, but there isn't a time when you say "today, my income got cut." Also, since some prices rise less than others, relative prices rebalance without being quite as noticable as they would be without inflation.

Still, in the long run you have exactly the same situation: what you make (regardless of the number on your pay check) is down relative to what you have to spend to buy the same stuff.

[Slartibartfast]

No evidence is presented to back this claim. Fully a third of retirees subsist solely on Social Security, a program indexed to inflation.

By implication, fully two-thirds of retirees are less than fully reliant on SS, no?

No, I'm not going to substantiate "rather enormous", because it's not an exact enough claim to back. I am going to instead arm-wave it by noting that there is some continuum of elderly between the chunk of folks completely reliant on SS and the chunk that comprises a large portion of the wealthiest 1% that is non-negligible. Will they be enough to tilt a decision, if there even is a decision to influence, their way? I don't have enough information to say.

It is fairly well-known that people aged 55 and up are the wealthier, in general, than any younger age group. It's also fairly uncontroversial to suppose that people who have retired, or are planning to retire, have planned on some dollar amount per year to live on. Devalue the purchasing power of that dollar amount and you've got some unhappiness.

Presumably, a balanced portfolio of stocks/bonds will be, de minimus, inflation 'indexed'.

That presumes much about judgement, investment skills, patience, etc of the retiree, I think.

[bobbyp]

Slarti,

You presume that the non-negligibles have "planned some dollar amount per year to live on" but are inexplicably unable to do a little financial planning that could be done on the back of an envelope? Really? You presume greatly.

But I'd wager further than a very non-negligible % of that non-negligible cohort have very little in the way of retirement savings beyond some house equity and a bit of IRA/401k assets. Think about this: What kind of nest egg is needed to live to, say, 80 at an inflation adjusted $50k/year? Assume $20k/yr SSI. That's about $400k you have to have in hand right now if you're considering leaving the work force. What percentage of the population age +55 can reasonably assert they have that kind of net asset base? My arm waving says you will be shocked to find out how low that number is....like you say, it's non-negligible.

This cohort is skating on thin ice as retirement rushes upon them (yes, it rushes). And they are the wealthier, I would agree.

So what does that say for the state of our country? To me it says this: We have needlessly chosen an arbitrary social arrangement that exalts the the well-being of the few at the expense of the many. We have heedlessly expended vast resources on circuses and empire, and the outlook is distinctly gloomy.

As to the decision...yes. The wealthy shall make it. They don't need numbers. They have their money to speak for them.

[bobbyp]

So tell me, Brett: How does a government that can create money out of thin air decide "what it can afford"?

[Ian Ainslie]

Banana coffee, please.

[Hartmut]

Somehow my comment from yesterday disappeared.
---
I said:
(Hyper)inflation (just) weakened Weimar, deflation killed it.
(Applying for the oversimplification of the week award admittedly)

[Countme-In]

HaHa! One more reason for the President to declare default on the entire U.S. debt.

http://thinkprogress.org/economy/2011/07/21/274428/mcdonnell-debt-ceiling-flip-flop-credit/

Bring it all down.

These people want hell. So do I.

[wj]

Countme-In, it is one thing to wish these idiots to experience the hell that they are trying to land us in. It is quite another to wish to be there with them. Unfortunately, I don't see a promising way to get them to lie in the bed that they are making, without the rest of us suffering along with them.

[Roland]

Well, the inflation-indexed income programs all depend on Boskinized inflation stats, which are deliberately rigged to understate inflation. Gotta love that exquisite science of hedonics...

Don't feel bad. Almost every government in the Western world did the same thing, around the same time, and for the same reason. The apparatchiks looked at the demographics and did the math.

As has been noted in these comments, it's easier to let inflation cut incomes, than to try to cut the nominal incomes. In Canada, the Mulroney government tried to partially de-index old age pensions in the 1980's. The resulting political storm taught them a lesson: just lie about the inflation rate, and let the difference between real and official inflation rates flay the seniors slowly and quietly.

People here talk about the virtues of inflating away debts. Don't they realize that the loose money policies of the 2000's caused a boom in housing prices, which forced millions of people to over-borrow for their homes?

And since when is punishing savers good policy? It wasn't the savers who nearly destroyed your banking system in 2007/08.

If you want to punish rich rentiers, why not just raise their taxes? Oh yeah. You can't do that thing there.

One more thing: controlling the world's main reserve currency has both advantages and disadvantages. The disadvantage is that you should not regard yourself as being free to inflate as much as you want.

Of course, what would one of today's Americans understand about duty?

[haalxb]

If you want to punish rich rentiers, why not just raise their taxes? Oh yeah. You can't do that thing there.http://pink-boots.yolasite.com/ pink boots
http://grey-boots.yolasite.com/ grey boots

[grey-boots]

People here talk about the virtues of inflating away debts. Don't they realize that the loose money policies of the 2000's caused a boom in housing prices, which forced millions of people to over-borrow for their homes