We Do Not Like Inflation

A Benjamin Cole post

Market Monetarists and other have been exasperated beyond measure by certain Federal Open Market Committee members’, and thus the Federal Reserve’s, peevish fixation on inflation.

We ponder why the Fed undershoots even its dubiously low 2% (on the PCE no less) inflation target for years on end, or why it even matters that much if inflation is 2% or 3%. In the vernacular of the blog-street, WTF?

In reply, anti-inflationists drag out the Weimar Republic, or cite the now-aging numbers-and-formulas-laden texts of Robert Lucas, in which Lucas pulled out all the stops, and at one point suggested that a 10% rate of inflation might be associated with a 1% decrease in GDP growth.

But we are not even close to 10% inflation now and have not been in decades, and moreover an economist in 2009 from Boston College re-ran Lucas numbers, fitted Lucas’ Nobel Prize-winning “log-log” data to more-recent observations, and concluded the cost to economic growth of inflation was much less than Lucas had calculated. Lucas empirical observations were an artifact of the times. See here.

Meanwhile, the NY Fed, in 1997 reported that lost output “is quite low for inflation rates less than 10 percent, remaining below 0.10 percent of GDP. Only when inflation rises to above 100 percent do these costs become appreciable, climbing above 1 percent of GDP .”

This is the Great Bogeyman? 0.10% of GDP?

Not that I have 100% faith in the Boston College or Fed NY efforts either. Economic models always, and I mean always, find what the model-makers want, left-, right- or upside-down wing.

So Why Is The Fed Talking Tightening When Inflation Remains Below Target?

It is not about macroeconomics.

We have that from Bob McTeer, a former FOMC (1991-2004) member, so he has some insights that bloggers and academics do not.

McTeer wrote recently on his interesting blog, “My opposition to inflation targeting was not very sophisticated. I simply though of inflation as bad and didn’t want to officially condone it.”

McTeer continues, “Frankly, I’ve been surprised at the apparent general acceptance of the goal of two percent inflation by the talking heads on financial TV. I’m not surprised at its support from the academic community. I would have thought that the talking heads would take a less sophisticated position, as I did.”

And finally McTeer says, “This is guesswork on my part, but I really doubt that members of the FOMC really want two percent inflation. Extrapolating from my own thinking on the subject, I’ll bet they would prefer one percent inflation, or even lower…. What I really want, and I’ll bet many of them agree with me, is not two percent inflation, but no deflation.”

Well, McTeer is wrong on that last one. Charles Plosser, Philly Fed President has rhapsodized about deflation.

I Hate Inflation Too

Of course, no one likes inflation, as all of us seem vulnerable to the fear that when prices going up, the price we charge for goods and services will not—unless we actively raise our prices.

And there is yet a vast socio-business nicety afloat that salves business relations, and that is that we are not trying to profit off one another. No one sends a letter to clients to the effect, “I am raising prices as I want to make more money, and thus I am charging you more. I am even aware some of you have no ready options, so I am gouging you while I can.”

It is bad socio-business form to raise prices, and most of us prefer not to. Even asking the boss for a raise can be a very dicey matter. How about, “Since you are short-handed now, I figured it is good time to demand a raise.”

Instead we send letters about how “inflation has gone up, so our charges must, alas, also. We fought against it for so long, but are compelled….blah, blah, blah.”

Monetary Policy

So, we do not like inflation. But are human social emotions the right way to make monetary policy?

What is the point of having a central bank with the power to print or “unprint” money—fiat currency—if that power is used only to tighten a monetary noose around the economy’s neck?

And I ask the question again: What is better: Economy #1 with 3% annual growth and 3% inflation; or Economy # 2 with 2% real growth and 2% inflation?

The Fed would tell you that Economy #2 meets policy objectives. Think about that. The Fed is within policy objectives in Economy #2, no matter how long that goes on, but not when in Economy #1, even for one minute.

After all, we do not like inflation.

5 thoughts on “We Do Not Like Inflation

  1. “Only when inflation rises to above 100 percent do these costs become appreciable, climbing above 1 percent of GDP .”

    Benjamin, let me ask you, At 100% inflation, with annual salary increases, a person of lower middle class that is living on the margin, how are they doing in month 12 when their salary has not yet been raised and their purchasing power has been cut in half? When they do go demand a cost of living raise, do they ask for double or now extrapolate out expected inflation for the following year and ask for 150-200%? What if inflation reached 100% but by exponential growth? Do they now extrapolate it out and ask for 300-500%??

    I finished my career doing quite a bit of complicated long dated structured deals. In the USA environment I wouldn’t hesitate to price you out a 30 yr deal on something like energy or aluminum. At 100% inflation where do you price me aluminum for just 2 years from now??? You CAN”T!!!

    Ask Marcus what it is like to speak to a Brazilian in terms of annual anything, they all speak in months, and this is almost 2 decades since having a relatively stable currency. Business can not plan at 50-100% inflation. Difficult enough at 10%.

    ….just a thought…

  2. Derivs-

    Oh, you are right. That is not my point. I am not advocating 100% inflation.

    My point is that there are studies that show very low costs to various rates of inflation. Some contend that a modest amount of inflation—say 3%—actually helps growth through the sticky-wages-prices-money illusion and money supply growth idea.

    In general, I prefer NGDPLT as central bank policy.

    If forced to IT, I think the Reserve Bank of Australia is perhaps right, shooting for 2% to 3%. The People’s Bank of China now has a 4% IT.

    The 2% IT, especially when it becomes a ceiling, especially during a recovery from the worst recession since the Great Depression, is perhaps also a monetary noose.

    But thanks for writing–and sometimes I exaggerate to make a point, But then, economics can get a little dull without hyperbole—just ask the inflation hysterics!

  3. If I had to choose between inflation and inflation targeting, inflation would win the day – easily. And it’s interesting that the inflation hysterics harp on the costs of inflation without comparison with the alternative cost to growth that appears would be easily 1% of GDP on the difference between the 1% and 2% marks on the PCE. But I guess we just can’t miss what we’ll never have….

  4. Dajeeps—you have raised a key point: at low rates of inflation does monetary stimulus yield much more growth than inflation? I bet so.

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