A Benjamin Cole post
Sometimes we forget to ask, amid the perpetual pompous pettifogging and sanctimonious sermonettes about the evils of inflation, the basic question: What is so bad about inflation?
The freshwater St. Louis Fed answered that question back in 1999, in readable piece entitled Looking at the Shoe-Leather Costs of Inflation.
Author Michael Pakko starts out by clarifying that inflation per se generally does not harm living standards, in fact that is a misunderstanding of amateurs, who see prices going up but not their prices or incomes. Of course, somebody else’s prices and incomes did, and macroeconomically that is a classic wash.
Yes, condemning inflation that way is a fool’s game, admits Pakko. But then sets us straight: “One general class of inflationary consequences is sometimes referred to as the “shoe-leather” costs of inflation: To avoid the erosion of their purchasing power due to inflation, people have to spend more time and effort protecting the value of their nominal assets—wearing out their shoes on the way back and forth to the bank.”
Now, if you are like me, you wonder if that statement was already dated in 1998, and is positively ensconced in the Smithsonian Institution now. Most people and businesses can keep money in interest-bearing accounts, or even invested on Wall Street until they need it, liberated with a few strikes of the keyboard—from their mobile phone no less.
And even for the cash crowd, 5% inflation or less is not enough to make one spend the whole weekly paycheck on Friday night.
To be fair, Pakko concedes shoe-leather costs become manifest only in hyperinflations, of the type never seen in the U.S. Indeed, since the Federal Reserve was created in 1913, we have had but few years of even double-digit inflation. Of course, Pakko devotes a lot of foreboding ink to the Teutonic hyperinflations, that ever-ready redoubt for the tight-money enthusiasts.
With the German price-hysterias of the 1920s as backdrop, Pakko then suggests inflation creates a mandarin class of sorts: “In the United States, the increase in inflation from the 1960s to the early 1980s was also associated with an increase in the relative size of the financial sector. For example, the fraction of the labor force employed in the finance, insurance and real estate (FIRE) sector rose from about 4.6 percent in 1965 to just over 6.7 percent during the mid-1980s. The growth of this measure slowed and turned downward following the disinflation of the 1980s.”
I guess Pakko is suggesting that the FIRE employees are parasitic, and maybe they are, even as they burn the shoe-leather minimizing balances on behalf of compromised customers. In any event FIRE employment grew like topsy through the even less inflationary 1990s and 2000s, as greater heaps on investable wealth were generated in the U.S.
Some so-called NAIC codes have changed, but it looks like about 8% of domestic private employment in 2007 was in the FIRE industries. (See here). This despite automation that cut a lot of back-office jobs.
There is a lot of money to be made managing money, what with capital increasingly abundant in the last 40 years—that is the real story.
Pakko sums up: “Wearing out your own shoe leather is one thing, but to understand why economists rather than shoe cobblers are concerned, consider the effect on the economy of people’s economizing on money balances, i.e. holding less cash. Leisure and work effort both decline to accommodate these inflation-hedging activities, so production also falls, and the economy contracts. In addition, there is a decrease in the stock of productive capital because inflation results in less business investment.”
Huh? The non sequitur “inflation results in less business investment” stands out like baseball player tossing out the first pitch to open up the Super Bowl.
Where did that come from?
Is a business operator likely to invest in plant, equipment and training workers if he thinks prices in general will be higher, or lower, in the future?
I cannot imagine buying real estate or capital equipment in a deflationary environment—but hey, that is just me.
Economics today is not so much economics, as politico-economic deontology, that is, ethics, morality—and, less importantly, the pursuit of national prosperity—through duty.
It does not matter whether zero inflation or deflation will lead to more prosperity—many economists, pundits and policymakers believe we have a duty to get to 0% inflation (or deflation) and stay there.
The 0% goal remains perhaps an economic cure-call, but more importantly an obligation or political badge of honor, notwithstanding the examples of deflation on Europe and Japan.
I have never heard a sound economic argument for squelching off real growth, profits and employment to reduce moderate inflation.
Moderate inflation just ain’t that important, and probably has a few positives.
2015 Prediction Bonus Exclusive To Readers of Historinhas: Inflation and interest rates will be lower than most economists expect.