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What's wrong with: In the aggregate, spending equals income, so other than menu costs, etc., inflation is neutral for the population as a whole. However, it's not necessarily neutral for every individual and I worry that my purchasing power will decline. Therefore, inflation is something I fear.

foosion: the "uncertainty" theory would predict that people don't like *changes* in inflation. If the Bank of Canada has been hitting 2% inflation for the last 20 years (which it has, on average) people who feared uncertainty would dislike 1% inflation just as much as 3% inflation.

Plus, that's not what Mother says, and not what my first year students say.

"Let's make the inflation fallacy true!"

But what if the fallacy is an oxymoron?

Everyone has savings, even if the "savings" are as small as the last paycheck.

If the last paycheck is used to by beer, it is very annoying to see the paycheck only buy 100 beers, not the 110 expected before INFLATION raised the price of beer.

Most people see the loss of saved purchasing power due to inflation. This does not seem to be an inflation fallacy.

It is much harder for economist or business people to explain the difficulty of acquiring the increased operating capital needed to keep a business open in times of high (and ever higher) inflation. Under 10% annual inflation, a business that needed $100,000 in operating money will need $110,000 next year. Finding that extra 10% (it needs to be after taxes) is a huge challenge in a competitive environment. I think the inability of business to fund increasing operating cost is the main reason that economies collapse in high inflation situations.

Roger: there is an inflation tax. But so what? If the government gets revenue from the inflation tax/seigniorage (which is a tiny tax anyway, at 2% of 5% = 0.1% roughly for Canada) it can lower taxes elsewhere. And all taxes are distorting. (Though, with more sophisticated analysis, you can show that the inflation tax has bigger distortions than income or sales taxes. That's the shoeleather cost thing.)

Roger: "Finding that extra 10% (it needs to be after taxes) is a huge challenge in a competitive environment."

No it isn't. It's no more difficult than persuading lenders to rollover the same $100,000 in a world of 0% inflation. It's the same to finance $110,000 under 10% inflation as $100,000 in 0% inflation. They are worth the same.

I feel like somebody can replay the old 1979 SNL skit on Jimmy Carter "We can all be millionaires" here. However, inflation during The Great Recession has very tame and rarely poking its head over 2% since 2010 despite several oil price increases. And yes the US wages have not kept up but this modest inflation and stagant wages is probably easier during a global labor glut than lowering wages 10%.

@Sparks:
> Everyone has savings, even if the "savings" are as small as the last paycheck.

That's not strictly true. Those in debt still have negative savings in spite of the cash balance. An immediate, unexpected, and universal jump in the price and wage level by 10 million percent would be *wonderful* news for those in a net debtor position, because it would amount to an obligation-free default.

Covnersely, those holding net positions of financial, nominal-terms investments have very strong reasons to prefer stable (or unexpectedly lower) inflation, since it improves their real-terms position.

@Nick:
>> Let's target NGDP. With the Bank of Canada holding the time-path of NGDP constant, any inflation would be a bad thing precisely because it would reduce real income.

... and that's actually one reason I think NGDP targeting is clever from an equality standpoint. If an NGDP target is met, a real-terms recession would result in an increased inflation, which in turn would help alleviate debt burdens and make consumer retrenchment a good deal easier.

@Paul Krugman:
> the great danger facing advanced economies is that governments and central banks will do too little, not too much.

That's not an inflation story, that's a zero-lower bound story. I remember when we last had the posts here on the Taylor Rule and false expectations: if the initial policy response is too tight (with a basic Philips Rule), then a central bank can be stuck at the zero lower bound over several interest-rate periods. With a Taylor Rule, the CB can *always* tame too-high inflation, but it may be helpless to promptly deal with too-low inflation with only interest rate tools.

@Nick:
>> "Because if all prices rise 10% we will only be able to afford to buy 10% less stuff. Duh!" Except the "Duh!" is silent, because my students are too polite.

That's interesting because it reflects a belief that wages are stickier (even upwards) than general prices. And inflation-targeting monetary policy should look at the stickiest prices.

I wonder just how true that folk belief is.

I wonder how people in Saudi Arabia or Kuwait view inflation. Because unlike in most countries, an increase in gas prices is associated with increasing wealth. And gas, being something expensive frequently purchased, is a key barometer of inflation for the average person. So do they think inflation is good?

I believe that most of the oil-producing nations in the Middle East also heavily subsidize gasoline for consumer use. The food price level would probably be a better one-stop inflation barometer.

Once you allow for behavioral effects, then the implications are ambiguous. On the one hand people interpret inflation as declining purchasing power, but on the other hand that means they mistake their wage inflation as increases in real income. So, I wonder about the magnitudes of those effects. If they exactly cancel out, then people behave as if they understood inflation correctly anyway. But it could be that they are more optimistic about nominal wage hikes than they are pessimistic about price hikes, or vice versa, which would have aggregate demand implications separate from the conventional channels by which inflation affects aggregate demand.

Majromax and Collin: an increase in the target rate of inflation may or may not cause real income to fall or rise. Ultimately, that's an empirical question. What's wrong with the inflation fallacy is that it is an *invalid* argument. It forgets that we earn our income from producing and selling goods. If the price of apples rises. that is as much an increase in the dollar incomes of the apple seller as it is a rise in the cost of living of the apple buyer.

Plus, *wages* are not the same as *income*. So whether wages are or are not sticky does not affect the invalidity of the inflation fallacy.

But sometimes, fallacious arguments do have true conclusions. Standard macro does say that, past a certain point, an increase in the inflation target will reduce long run real income.

Matthew: I think that most people see only a tenuous relation between inflation and incomes. They see the direct effect of higher inflation on the cost of living, but see the effect on their dollar incomes as some indirect and therefore very uncertain. "If prices go up 10%, why would that cause my income to go up 10% too? It didn't last year!" Your price rise is inflation; my price rise is something I struggled for.

When it comes to reacting to inflation, people might get it right, even if they see no causal link between the two. But when it comes to talking about policy, it's different.

I'm on-board with the analysis, but I think you are a bit too harsh on the reporter in this case. I think the implied argument is actually about "shoeleather" costs. Perhaps it is easier to raise output prices than re-negotiate long-term wage contracts. If so, there may be some distributional considerations, and I read the reporter as objecting on these grounds.

Nick,

If you think that's depressing, try convincing people that airlines charging for bags actually makes things more efficient. People love to complain about prices. I think it's a fundamental law of economics. This must be why they call it the dismal science? Although, you would think that people would figure it out by the time they get to ECON1000. I don't know how they manage to get through the first nine years....=)

blink: maybe, just maybe. But he does say "purchasing power", and doesn't mention income distribution.

Mike: yep. "But why should letting them charge for bags mean they would cut the regular fare??"

BTW, the origin of "dismal science(pdf)

I was just trying to be cute with that question, I thought I knew where that term came from although it turns out I was mistaken! I thought it was in reference to the "Malthusian catastrophe." Not sure where I got that though.

Mike: almost every economist used to think it was a reference to Malthus. I did.

Good, that makes me feel better. I actually feel like I have had this realization before but forgot about it. Thanks for the reminder!

But wait, does this mean that economics is not regressing after all?

The inflation fallacy concept is a fallacy itself because it excludes debt. When inflation is high (above 6%, e.g.) the real value of debt erodes away. When inflation is low (below 0) the real value of debt grows.

Net-borrowers (most people) would like to melt away their debts, especially today after taking on so much personal and government debt.

Net-savers (mostly the wealthy) would like to have the value of their savings increase through deflation.

So the inflation target is a fine tuning process. (The 2% number is entirely arbitrary.) If the target is too low, it will give savers an unfair advantage and punish borrowers. If it is too high, it will punish savers and give borrowers and unfair advantage. It has an enormous effect on the economy.

NGDP targeting seems like a bad idea to me. Not only does it include inflation targeting it puts an artificial limit on economic growth. Why start tightening the money supply if the economy is experiencing robust growth without inflationary pressures? This looks like a backdoor attempt to lower the inflation target over the long run.

It's better to keep the inflation target, which has more transparency. If a central bank tightens money to tackle imaginary inflation and causes a recession then we know who to blame and can build experience from the mistake. Attempting to put the economy on autopilot is foolish because no economic model exists that comes close to explaining the economy.

As Keynes said, "Today we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand." 84 years later we're back at square one.

Ron: "Net-borrowers (most people) would like to melt away their debts, especially today after taking on so much personal and government debt."

Which would explain why most people would like an (unanticipated) increase in inflation. Except they don't.

"This looks like a backdoor attempt to lower the inflation target over the long run."

Nope. Whether it results in lower or higher average inflation depends on what the target NGDP level-path growth rate is.

"Attempting to put the economy on autopilot is foolish because no economic model exists that comes close to explaining the economy."

NGDP targeting is no more nor less "autopilot" than inflation targeting.

The Bank of Canada targeted 2% inflation, and failed to prevent a recession.

Nick,

Did Canada manage to hit 2% inflation? (Not a smart-ass question, I don't know the answer)

If you ask the lay person whether inflation is good or bad, one gets the responses highlighted in the article. Economists have successfully communicated that inflation is about consumer prices. But, inflation is also about wages.

If you ask the lay person "how big an increase in wages s/he wants" you'll get a different answer. This has not been communicated effectively, even amongst many 4th year economics students.

@Nick: "I think that most people see only a tenuous relation between inflation and incomes. They see the direct effect of higher inflation on the cost of living, but see the effect on their dollar incomes as some indirect and therefore very uncertain. "If prices go up 10%, why would that cause my income to go up 10% too? It didn't last year!" Your price rise is inflation; my price rise is something I struggled for."

Personally I think this is most of the source of the fallacy. For most non-economists "Inflation" means reducing their purchasing power. "Raise" means increasing their purchasing power. Because the rate of "Raises" is often not well correlated to the rate of "Inflation" (due to real-terms wage reductions, etc) many people see them as separate processes. Additionally few people experience the headline inflation (much less core-inflation). For example, for me the most critical factor is inflation in boat berthing. Everything else is small enough to be noise. But my "Raises" rate depends on professor-wage inflation. Those aren't well linked in any realistic universe. For my girlfriend, perhaps the critical factor is clothing-inflation. She doesn't work in clothing, so again wages and "Inflation" are delinked from her perspective. So much of the fallacy is applying "what's good for me" in the small and short term to "what's good for the economy" in the large and longer term.

Anyway, it's still a fallacy, but surely we can understand why it makes sense to (non-economist) individuals.

(I left out the debt argument because presumably banks include estimated inflation in setting rates. Hence it is not the level of inflation that matters to borrowers - since that is priced in - but inflation surprises. And of course, it's only really "Raises" surprises that matter to the individual).

It is a failure of economics, that policymakers now speak of "stable inflation" rather than "stable prices".

It is a refusal to admit this failure, when economists call for even more inflation.

Why inflation is a bad thing: It undermines our standard of value. That's a big deal. A nation's standard of value is like a nation's flag. Inflation drags it through the mud.

Any patriot will understand.

Squeeky: "Anyway, it's still a fallacy, but surely we can understand why it makes sense to (non-economist) individuals."

Yep. Only if we imagine a very simple economy, where everyone is a self-employed producer and seller of goods, is the fallacy fairly obvious. The apple-producer would understand that an increased price of apples is as much inflation as an increased price of bananas.

As Oupoot says, wage inflation isn't seen as inflation.

Arthurian: there may be something to that too.

> Only if we imagine a very simple economy, where everyone is a self-employed producer and seller of goods, is the fallacy fairly obvious.

Or one where most wages came in the form of profit-sharing.

Perhaps another source of the disconnect is that individual wages are stickier than wages in the aggregate. In the private sector, the best way to get a raise is often to switch jobs, even to an equivalent position at a different firm. Exercising this requires a job search, which is back to shoeleather costs. Changing jobs also imposes many qualitative costs not measurable on a paycheque, such as adaptation to a new work environment.

On the flip side, perhaps it's precisely *because* of the relatively low inflation target we have sticky individual wages. A 2% inflation target achieved means that prices change negligibly over the short term. If the inflation target were instead 10%, then cost-of-living adjustments would have to be the norm rather than the exception.

What Squeeky and Majro said. Shoeleather ain't beanbag to the individual, and especially not to the individual family. And capitalists don't share their profits automatically with their employees. As I've said before, goods-price changes are continuous and my salary only changes once per year. And these variabilities of stickiness and time-variabilities of payments provide angles for non-productive opportunists to exploit. In short, I'm not paid what I'm worth (at least not timely), and yet I pay more for goods than they're worth (and timely to boot).

All employees would have to spend 50% of their time playing the labor market (shoeleather) to change that. Is that the definition of a productive society?

Jeff: "And capitalists don't share their profits automatically with their employees. As I've said before, goods-price changes are continuous and my salary only changes once per year."

That's an example of the inflation fallacy. Remember: CAPITALISTS ARE PEOPLE TOO!

(And you do not understand what "shoeleather" refers to. It does not mean "profits", or "taxes", or non-labour income, or "unemployment", or anything like that.

Jeez!

Ours the task eternal.

"Which would explain why most people would like an (unanticipated) increase in inflation. Except they don't."

Yes, most people don't realize the relationship between inflation and debt and how that could be beneficial to their position. They don't know what GDP is either (or NGDP.) They also apply household economics to macroeconomics unaware that austerity in a slump is self-defeating. (In short, a household is not an economy.)

So the ignorance of the masses happens to coincide with the self-serving Hooverian agenda of the plutocrats. Obviously economic policy predicated on ignorance and corruption is doomed to fail. As Krugman suggested in the article you cited, which I have believed for a long time now, the wealthy like bad economic policy because it causes recession and increases government debt, which allows businesses to downsize wages and benefits, and ends up crippling democratic government (i.e., "starving the beast.")

"NGDP targeting is no more nor less 'autopilot' than inflation targeting."

Sophisticated inflation targeting has an implicit dual mandate. It ignores temporary spikes and takes into consideration a number of factors like the employment rate that affect GDP growth and prices over the medium term.

Ideological inflation targeting is bad policy. There was a temporary inflation spike in late 2011. The BoC and Fed ignored it. The ECB and Sweden's central bank hiked interest rates. This sent the Eurozone into a double dip recession. It also destroyed Sweden's recovery which was among the strongest of developed countries.

The ideological inflation targeting of John Crow was even worse. Made the 1991 recession in Canada far worse than it had to be. Caused debt/GDP to spike from 70% to over 100% creating a debt crisis. (But then again, as I stated earlier, bad economic policy can work out well for the anti-democratic-government "starve the beast" plutocrats.)

"The Bank of Canada targeted 2% inflation, and failed to prevent a recession."

I think it's pretty clear by now that no amount of monetary stimulus could've undone the damage caused by the financial market meltdown of 2008. The Fed has held interest rates at 0.25% for over 5 years now, plus QE.

Japan suffered a housing bubble collapse and has been stuck in a liquidity trap for 18 years with interest rates at or below 1%.

Under these conditions the counterweight has to swing far to compensate. This requires a higher medium-term inflation target (e.g. 4%) and a heavy bombardment of government spending (WW2-like.) As Japan has shown, the long term can be very long indeed.

@Nick Rowe:
> That's an example of the inflation fallacy. Remember: CAPITALISTS ARE PEOPLE TOO!

Sure, but doesn't it explain most of the discrepancy?

For a median household, the inflation fallacy holds over the short term: prices continually adjust whereas wages only sporadically adjust. Inflation appears as a reduction in purchasing power, whereas nominal wage adjustments aren't called inflation.

For a lower-income household, the inflation fallacy is largely true. These households don't have competitively-set wages and are dependent on either minimum wage laws or social support. Again, both of these are adjusted sporadically for inflation, whereas costs adjust continually.

For an upper-income household, the inflation fallacy is false but the debt issue is a concern. These households are more likely to have net positions in nominal-terms financial instruments, and the value is reduced by higher-than-expected inflation (or an increase in the inflation target that occurs over the lifetime of an issue).

So going back to the original point of the post, I think that the rich and powerful have both fallacious and wealth-based reasons to object to an increase in inflation. The median and poorer have reasons that are fallacious in the longer term but can seem rational over the shorter term.

Majromax: wages are sticky, and prices are sticky too. Which is stickier? If prices were stickier, we would expect to see procyclical real wages. If wages were stickier, we would expect to see countercyclical real wages. My understanding of the literature is that it is very hard to say whether real wages are pro- or countercyclical.

But, the more I think about it, the more I'm thinking that this whole way of looking at the problem -- that knuckle-dragging lefty way of categorising things -- is just really really stupid. There are a billion different ways of categorising people into two groups. And so a billion different ways of ask the question whether one group gains relative to another. If someone said "Do the freemasons/Jews/tall people lose from higher inflation?" we would immediately recognise that person as a nutjob.

@Nick, Perhaps I was too terse. The shoeleather to which *I* was referring was the (wasteful) effort I and all wage-earning workers would need to expend to ensure that our wage inflation was comparable in timeliness/(non)stickiness/quantity to the price inflation we experience (continuously). One difference is that price-to-consumer is not negotiated but simply set/reset, whereas I cannot do that with my wages. (Another difference is the frequency of the increment as already mentioned.) In short, the capitalist holds all the cards on his/her side of *both* the price and wage setting.

Of course capitalists are people too, but there are far far fewer of them than wage-earners and they hold all the cards (power) as above. (E.g. capitalists have the option to hoard large percentages of their money (profits), where wage-earners generally don't, if they want to eat.) I don't think it is "nutjob" to point out *that* way of categorizing people when we are discussing *capitalism* after all, right?

Maybe in the end, the problem is one of so-called "concentration of capital"?

Trying to summarize another way, and bringing it back to inflation: Higher inflation creates a "rat race" or "hamster wheel" or "ratchet" or "keeping up" effect on *both* sides of the capital/wage equation. Because real-world adjustments are not the smooth frictionless instantaneous changes in economic variables entailed by the math of macroeconomic models. The faster that prices need to increase (to pay higher wages), the more diligently capitalists will need to keep an eye on things, and the more frequently they will need to go thru the inefficiencies of raising prices (literally changing shelf labels, etc. etc., again and again). The faster that my wages need to increase to keep up with rising prices, the more inefficient labor I will need to expend just keeping an eye on the job market, negotiating new salaries, changing jobs, and/or moving my family, as above.

Again, I am just a layman. But all the above is "shoeleather" right? Is there any empirical data, and a model, for the percentage of labor expended on shoeleather as a function of the level of inflation?

Thanks in advance.

Jeff: Yep. But we call those costs "menu costs". (The analogy is to a restaurant having to print new menus with new prices every couple of weeks.) But I don't think there's any good aggregate data on menus costs (I may be wrong) because it's so hard to figure out what is included in the real world.

"Shoeleather costs" are when you keep running to the market and back to spend your money quickly before it loses value, and wear out your shoes. (Again, more of a metaphor.)

Thanks. Agreed as to "how to figure out". As in, real estate agent and moving company activity includes some of that "shoeleather" inefficiency, but they don't distinguish out shoeleather moves from everyday moves. I've got to think that it can be inferred/estimated though, given a baseline of very low inflation such as we've had now for 5 years. Similar with "menus" -- can't a baseline be determined?

Thinking more about it, isn't all "pure service" in an economy just the same wasteful "inefficiency", regardless of its cause? Of what productive value is the server's work in a restaurant, as opposed to the cook's which is where value really is added to the raw food? What's "productive" about real estate negotiations, as opposed to home construction? Financial "services"? The entire tourism industry? Education? Hmmm. Something "wrong" with the idea, but not so clear what...

Nick,

Please allow me to state rather bluntly that you and the commenters are missing the point: I searched this entire page for the word "moral". It is not here. The public face of conservatives and "centrists" about this issue is rooted in a sort of false morality about how things should be. The problem of course is that is not how things are and the centrist "morals" make things worse for people.

Once you see the framing of hard money or low inflation in moral terms then the animosity and what Profs Krugman and Delong are saying makes more sense. These are the bearded hippies telling the Davod Brooks' of this world that in fact these simple maxims about "living within your means" and whatnot are the "southern product of a bull facing north". And believe me, some in the conservative circles despise the bearded hippies. (Yes, yes Brad is clean-shaven.)

So when Andrew Sullivan (not to be trusted on economic matters but very trustworthy on morality and decency and fairness in journalism and public policy - ie torture, gay marriage, transparency, sponsored content) was declaring his wish that Obama would sweep away the tired arguments of the sixties, this is what he meant. Of course these arguments are still here. It is still the bearded hippies vs the David Brooks' of the world.

(In case it isn't completely obvious, I tend to side with the hippies - except when they get paranoid, ie vaccines.)

Chris J: That is an excellent point--there is a lot of moral indignation about inflation. Of course, one is then led to wonder whether that is moralising self-interest, but certainly moral indignation is a factor in attitudes and rhetoric. Even the fact that hyperinflation tends to disappear as countries democratise provides some support for the moral indignation factor.

The bigger fallacy is that central bankers and economists think they can control inflation like you turn up and down a thermostat when really it is like a nuclear reactor that can get out of control and melt down your currency. To understand how easily and quickly inflation can get out of control check this out:

http://www.howfiatdies.blogspot.com/2014/09/krugmans-missing-model.html

Jeff: hairdressers, doctors, car mechanics, and teachers produce services that are as useful as clothes, cars, food, and houses.

Chris: OK. If we think of money as a yardstick that measures value, then inflation is like fraudulently messing around with weights and measures. Selling underweight loaves of bread.

Vince: From a very quick skim, I think your model is similar to Cagan's model of inflation: MV=PY. V is a positive function of expected inflation. Expected inflation is a positive function of actual inflation (adaptive expectations).

Paul Krugman will almost certainly have been taught that model (or something similar) in grad skool, like I was (he's the right age). You can add an additional equation to that model S = (dM/M)(M/P) where S is the real seigniorage revenue the government gets from printing money. It only leads to explosive hyperinflation if S is too big. Which is what happened in Zimbabwe, where Mugabe tried to pay his soldiers and supporters by printing money.

If Krugman knows of Cagan's model, then how can he say again and again that a country that prints its own money can't get into trouble from too much debt and deficit, like Greece that does not print its own? That nobody has a model for countries printing their own money getting into trouble from too much debt and deficit. He has said this many times. If he knows that for a country that prints its own currency the danger is run away inflation, doesn't it seem like he is being less than forthright?

Vince: he's talking about a different type of trouble.

"...doesn't it seem like he is being less than forthright?"

That's what I like about you Vince: you may have strong views, but you're very polite... for a blog commentator. :D

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