March 4, 2012

Disinflationary

Pity poor brother jg. Any other right-leaning blog would hop on his "Stealthflation" bandwagon and give him a heroic ride to the store to purchase overpriced commodities. Yet he encounters extreme obstinacy at ThreeSources. Has he a new ally in brother Bryan? Time will tell.

Milton Friedman said "Inflation is always and everywhere a monetary phenomenon" and argued for a rules-based "computer" FOMC. I would happily buy into that.

But if anybody is going to use a "basket of goods" deflator, they have to account for disinflationary forces. Insty links to an Arnold Kling excerpt from the book Abundance (which I just bought).

Twenty years ago, most well-off US citizens owned a camera, a video camera, a CD player, a stereo, a video game console, a cell phone, a watch, an alarm clock, a set of encyclopedias, a world atlas, a Thomas Guide, and a whole bunch of other assets that easily add up to more than $10,000. All of which come standard on today's smart phones...that's how quickly $10,000 worth of expenses can vanish.

I suggest that ten grand buys a few tortillas, and that corn prices are affected almost as much by ethanol mandates and subsidies as monetary policy.

Economics and Markets Posted by John Kranz at March 4, 2012 11:14 AM

Heh. Any publicity is good publicity, right?

I'll stipulate that corn prices are effected more by ethanol mandates and subsidies. How does this disprove monetary inflation? I call it superposition.

And what about the not well-off US citizens? True, their relatively affordable smart phones give them things their forebears could never afford but they're still paying X times as much for corn. Where is the magical technical deflator for corn? What foodstuff is as nutritious for a hundredth the cost?

Posted by: johngalt at March 4, 2012 2:56 PM

John is correct. JG does have an ally when it comes to the advocation of 'hard money'.

There are however, several different topics being discussed here. First, is Friedman's famous quote on inflation. I would take it a step further and say that inflation specificaly describes what is taking place to the money supply, not to prices. Increases in prices can be the result of inflation, but are not inflation itself. For instance, a rise in prices because of an increase in the quantity demanded in the short run is not always a result of inflation. We have to ask ourselves if demand was increased because of inflation or is there another factor leading to more of a particular good or service being demanded?

Also, Friedman did at one point say that we could fix recessions by merely dumping dollars out of a helicopter. A theory that I'm guessing most on this blog would not agree with.

The next point being talked about here is how we go about measuring inflation. I'm sure all of us are familiar with the CPI and how it works. The only thing I will say about the CPI is that it does not include food and energy, so in this writer's opinion, it doesn't mean very much. Which brings me to the last point.

Inflation vs deflation. JK is spot on with his comments regarding smart phones and how technological innovation can offset inflation. But it is this very fact that will prove my point below.

As economies grow, more people become educated, newer and more advanced technology is created, and we all become more wealthy as the "wealth pie" grows. Therefore, it would stand to reason that as we have researched and invented more efficient farming techniques, food should have become much cheaper. The same theory can be applied to energy as well.

Why then is it, that while the computer industry has brought what was 20 years ago super computing technology to my iPad, the cost of food and energy continue to rise when we would all concede that the technology behind both of those markets has improved by leaps and bounds in the last 100 years?

The answer is the Federal Reserve. Since 1913, the dollar has lost ~97% of its purchasing power. If we look at the 100 years prior to 1913, we see the opposite happen has markets and technology expanded to increase the size of the wealth pie.

In a totally free market, goods and services become less expensive as time goes forward, assuming that technological innovation is taking place. If however the goods that we bought in 1913 cost more in real terms (inflation adjusted) today than they did then and if we all assume that technological innovation has taken place in that same time period, then the only explanation that is left is the erosion of our purchasing power over time.

Posted by: Bryan at March 5, 2012 11:27 AM

The President has (figuratively) dumped dollars out of a helicopter. The recession continues.

Regarding your last paragraph: How is the price of goods adjusted for inflation over time except by comparing the relative purchasing power? It appears there's a bit of a circular argument here.

Posted by: johngalt at March 5, 2012 6:44 PM

There is simultaneously some good analysis and some misinformation here. I would like to address the misinformation.

"Friedman did at one point say that we could fix recessions by merely dumping dollars out of a helicopter. A theory that I'm guessing most on this blog would not agree with."

No. He never said that. His helicopter drop was a thought experiment to illustrate the effects of an increase in the money supply.

"I'm sure all of us are familiar with the CPI and how it works. The only thing I will say about the CPI is that it does not include food and energy, so in this writer's opinion, it doesn't mean very much."

No. This is wrong. The CPI does include food and energy. I think that what you are thinking of is core CPI, which excludes food and energy prices because they are more volatile. I have no problem with the argument that the entire basket encapsulated in the CPI is a better gauge of inflation than the core CPI, but it is not correct to say that the CPI does not include food and energy.

"The answer is the Federal Reserve. Since 1913, the dollar has lost ~97% of its purchasing power."

Relative to what? You cannot simply mean that the price level has risen by 97%. Wages, after all, are prices too. Perhaps to better illustrate my point, I can respond to the following comment:

"In a totally free market, goods and services become less expensive as time goes forward, assuming that technological innovation is taking place. If however the goods that we bought in 1913 cost more in real terms (inflation adjusted) today than they did then and if we all assume that technological innovation has taken place in that same time period, then the only explanation that is left is the erosion of our purchasing power over time."

Goods are becoming less expensive. Adjusting prices for inflation is the wrong comparison. For example, suppose that prices of all goods have increased 1% in real terms. Well, wages are prices too. If wages have increased by 1% in real terms over the same period, we would be no worse off under this scenario.

Rising productivity reduces the unit cost of production. This then gets translated into lower prices and/or higher wages. Thus, when we compare prices over time it is necessary to look at them in wage units rather than adjusting for price inflation. For example, according to the 1971 Sears catalog an 18.2 cubic foot refrigerator cost $399.95. A quick check at Sears reveals that one can buy an 18.2 cubic foot refrigerator for $450.49. Prices have clearly risen in nominal terms. One could consider whether they increased in real terms by adjusting for inflation. But what would this tell us? In short, not much. A more interesting comparison would be to look at how many hours the average worker would have to work to purchase that refrigerator. In 1971, the average wage was $3.73/hr. In 2011, the average wage was $19.47/hr. Thus, in 1971, the average worker would have had to work 107.2 hours to afford the refrigerator. In 2011, the average worker would only have to work 23.1 hours. The same result holds for TVs, dishwashers, toilets, and even bean bag chairs.

A NOTE: Please do not misinterpret my comments. I think that inflation is harmful. However, I don't think that inflation is harmful because it make things cost more in nominal or real terms. Inflation is a tax on cash balances (note that this is distinct from the argument above). High and variable rates of inflation are very harmful because they divert resources into predicting and dealing with inflation and therefore away from production. Price variability has negative consequences for contracts and other long-term planning, etc.

Posted by: EE at March 5, 2012 11:32 PM

@ EE -

I now realize in my haste that I did make a few mistakes in my earlier comment to JK's post. Working and writing a blog comment at the same time was probably not the best idea and as such some of my points require clarification.

Friedman's quote about dropping money out of a helicopter was regarding price deflation and not a recession (Although one is usually a symptom of the other). And as you pointed out, it was said more as a joke in "The Optimum Quantity of Money" than a serious policy suggestion.

You are also correct about my mistake regarding the CPI. What I was meaning to say was the PCE Index. Given your credentials, there is clearly no reason to explain what that is. (Sarcasm is most certainly NOT intended. Just wanted to make sure that was clear as it is the internet after all.)

Thank you for catching me on my mistakes, as I mentioned working and commenting is a bad combo. I will post more tomorrow on the point of why inflation is harmful.

Posted by: Bryan at March 6, 2012 12:26 AM

Enjoying the back-and-forth, and wanted to invite you to explain the economist jargon, like PCE, at least briefly. Then we lowly engineers can try to keep up. For the record, I fully agree with EE's analysis above.

While we wait for the next installment I'll insert my layman's view of inflation. The monetary inflation effects I worry about are dilution of value of saved wealth and the uncertainty of the future value of goods, both of which EE mentioned. However, my wrath is directed not at inflation per se, but high inflation that creates many times more and many times larger problems than does moderate (less than 2%) inflation.

A still greater negative consequence is monetary inflation's role in boom/bust cycles, such as it is. (And that will take an expert to explain.)

Posted by: johngalt at March 6, 2012 12:47 PM

Austrian Business Cycle Theory is clear on the effects of infla --

NUDE PICS OF OUR MRS. REYNOLDS?? (SFW, one level of indirection)

Sorry guys, blog law dictates that all monetary policy arguments must include at least a vague or comical reference to celebrity photos as a precaution against losing viewers.

Posted by: jk at March 6, 2012 2:50 PM

And if you read the linked post instead of just looking for the links, there is a poignant discussion of property rights:

The moral dilemma here is that these photos are not just stolen property. They represent the theft of a future revenue stream. Like everything else in a famous person's life, from tweets to party appearances, the nude photo can be monetized and by looking at them we are devaluing an asset belonging to someone else.

In the open market nude photographs can fetch up to $1 million if they retain the cache of novelty and are properly distributed. Each time we view one of these leaked or hacked photographs we are contributing to the decline in value of a potential future asset. The individual leaking the photos is exploiting a possible future revenue stream for the celebrity without their permission. Because a market exists for nudity, the leak is akin to someone stealing and releasing an early copy of a musician's single.

Plus, I don't think the link is there. Ah, well, back to work.

Posted by: jk at March 6, 2012 2:55 PM

I am also enjoying the discussion!

@ Mr. Galt here is a brief explanation of the PCE. Specifically the CPCE is the index that does not include energy and food.

http://en.wikipedia.org/wiki/Personal_consumption_expenditures_price_index

The more I have looked into my position on the matter, the more I realize that it warrants its own post. I will be working on a post regarding inflation and how it is measured and will try to post it by the end of the week.

Posted by: Bryan at March 6, 2012 2:55 PM

I've loved her since Firefly...:)

Posted by: Bryan at March 6, 2012 2:58 PM

Toldja he was a great find!

Firefly is something of a religion 'round these parts... I confess I have not seem her big hit new show, but I'm happy it has launched her.

Posted by: jk at March 6, 2012 3:06 PM | What do you think? [11]