The inflationistas are our friends; and inside and outside inflationistas

Noah Smith is doing something very wrong. The whole point of monetary policy at the ZLB is to create inflationistas. We need more inflationistas, not less, and so Noah should stop dumping on them, and saying their fears of inflation are groundless. For every inflationista destroyed by us laughing at their fears, central banks have to work extra hard to create stronger grounds for their fears and so create a replacement inflationista.

But we've got to be careful to make the important analytic distinction between outside and inside inflationistas. We want more of the former, and fewer of the latter. So it might depend on whether the former or the latter read Noah's blog.

It's a crazy old world, but that's the world we live in. And strictly speaking what we ideally want to create is not inflationistas but, ummm, "NGDPgrowthistas" (defined as those with a fear of suddenly high NGDP growth), but I'll take what comes.

We can define the looseness of monetary policy as the difference between two index numbers, Io and Ii:

Looseness = (Io-Ii)

where Io is defined as "outside inflationistas" or "percentage of inflationista sentiment in the general public outside the central banks", and Ii is defined as "inside inflationistas" or "percentage of inflationista sentiment inside the central bank". (Nerds might prefer a weighted average of sentiment rather than a simple percentage, but they're just being nerdy.)

(I would have defined them the other way around, by analogy with inside and outside money, but I thought this might confuse people who aren't serious monetary economists.)

Outside inflationistas think that monetary policy is too loose, so rush to spend their money now. Inside inflationistas also think that monetary policy is too loose, so rush to tighten monetary policy now. Obviously, the two groups of inflationistas have equal but opposite reactions on the economy.

Or, since what matters for monetary policy is 99% expectations of the future, and only 1% what happens today, a better measure of the looseness of monetary policy would be:

Looseness = 0.01(Io-Ii) + 0.99Ep[(Io-Ii)]

where Ep is public expectations of future "fundamental" looseness (Io-Ii).

So, to sum up, if you want a looser monetary policy you need to do three things:

1. Increase outside inflationistas.

2. Decrease inside inflationistas.

3. Increase expectations of outside minus inside inflationistas by going round yelling "Everyone except the Fed knows the Fed is going to create a lot of inflation, but those crazy fools at the Fed don't get it and never will! So spend your money now, while it's still worth something!"

Or, if you wanted to be boring, you might try to persuade the central bank to adopt an NGDP path target.

Comments

[Noah Smith]

I'll just repost my comment from my blog:

The inflationistas are NOT our friends. All their dire warnings have bounced off the market, which still says it expects low low inflation for many years. But the inflationistas may have had some influence on policymakers at the Fed, causing them to "taper" early, etc. So, nice attempt to be cute, but the reality is that inflationistas are likely to push inflation expectations - and inflation - lower rather than higher.

Nice try, Nick. Cute, but no. :-)

[J.V. Dubois]

I think this view may not be complete. Maybe I do not understand what inflationista means. There are two components to it - first one is how this person interprets signals about what inflation will be there in the future. Second component is what is preferred inflation for this person. And these two components may go in a different way.

Let us imagine Central Banker who examines latest CB forecast about inflation and growth and he will say that he sees healthy economy just around the corner so there is no need to do anything here. This fits your story - this is perfect example of too much inflationism in CB - it would be better if central bankers are more manly and admit that they are too optimistic about inflation, revise it down so they may boost it to the level they seem to prefer (the one consistent with the original and too optimistic inflation prediction).

But sadly you have another type of central bankers - they will admit that inflation is low and that things do not look good on unemployment side (we have a good start here, dont we?) But they will not do anything about it. Because in face of 1% inflation expectations from now on forever they create sentences like this "thanks to our highly accomodative policy of low interest the inflation expectations are well anchored below 2%". Or because they are afraid of debt bubble as is the case of Sweden. Or because they think that an army of unemployed is a small price to pay for the supply side reforms they were meant to ram down the throats of those lazy southerners [or maybe they are just insane, maybe both].

[Determinant]

Nick, you've got some causality problems. An inflationista is trying to predict the future, which is uncertain. A (good) Central Bank wants to bring an inflationary future about, so it has to take inflationary steps today. But the inflationistas hate that and fight and rail against it. If they win, the Central Bank won't take the inflationary steps and makes a policy mistake.

So in order to do its job, the Central Bank has to ignore the inflationistas and the inflationistas have to be ignored. So why be an inflationista and why listen to them? Listening to them leads you to a policy mistake.

Most times, economically unproductive activities which are costly (as being a inflationista is in this case) should not by definition exist in an any market where the actors have any degree of sense.

[Miraj Patel]

I think the Fed has held back or second-guessed themselves more than they should have because of inflationistas, especially ones on Capitol Hill who have threatened tighter control over the Fed, leading to lower inflation that we might otherwise have had due to tighter policy.

[Nick Rowe]

Noah: Doesn't your view imply that the Fed listens more to (say) Neill Ferguson than it listens to people like you, Paul, and Brad? And that it's the other way around for the rest of the general public?

But on the other hand, if Neill is a better statistic for (i.e. more closely correlated with) exogenous shocks to public expectations of inflation, that might be wise policy on the Fed's part, even if the Fed knows that Neill knows nothing. The Fed adjusts monetary policy to fully offset those exogenous shocks.

I'm trying very hazily to think of how to model this as a 3-person game. 1 is the inflationistas, who are the upper tail of the expected inflation distribution; 2 is people like you, Paul, and Brad; 3 is the Fed.

If market expectations of inflation haven't risen, mightn't that be because you Paul and Brad have been successful (too successful?) at attacking the credibility of the inflationistas? (Your friends have done their best to help you, but you keep destroying their efforts.)

Suppose there is an exogenous upward shock in inflationista sentiment, but the Fed observes that shock in real time (or at least, as quickly as the rest of us can observe it). The Fed responds by tapering earlier than it would otherwise have done, to leave the time-path of expected inflation unchanged, but it's still a good thing, in the sense that the Fed gets to return to normal earlier than it otherwise would have done?

JV: I was interpreting "inflationista" as a statement about a person's expectations about inflation, rather than preferences. Yes, it could be different if it meant preferences.

[Nick Rowe]

Determinant: assume that inflationistas have totally irrational expectations, and the central bank knows this. But that there are a lot of people who are inflationistas (or who are influenced by them). Since actual inflation depends on expected inflation, whether those expectations are rational or not, the central bank needs to listen to what the inflationistas are saying and respond accordingly. In fact, it is precisely because the inflationistas have irrational expectations, independent of what the Bank already knows, that their beliefs are an important source of additional information for the Bank.

Miraj: OK, the ones on Capital Hill are maybe inside inflationistas too. Good point.

[Edit: I meant CapitOl Hill. Forgivable Canuck mistake!]

[Determinant]

Noah: Doesn't your view imply that the Fed listens more to (say) Neill Ferguson than it listens to people like you, Paul, and Brad? And that it's the other way around for the rest of the general public?

This member of the public thinks that is a fair assessment.

Is also depends Nick on whether you want the fed to cause inflation or to react to higher inflation. In this game, you must specify whether the Fed (or any other central bank) is an active or a passive player.

[Determinant]

On Nick's Second Post:

Is this Post-Modern?

Facts are stubborn things, as John Adams said.

assume that inflationistas have totally irrational expectations

I can assume that, but the game itself is rational and a rational player will always win against an irrational player. Do strategy and tactics, studying the field and sizing up your opponent count for nothing? Faced with an irrational opponent, the player who studiously prepares will win every time. The price of foolishness and being exposed as a fool and having to pay for your foolery, in this case in cash.

Since actual inflation depends on expected inflation, whether those expectations are rational or not, the central bank needs to listen to what the inflationistas are saying and respond accordingly

No it doesn't to listen to them. Facts win over fools. The Central Bank just needs to act on its own conclusions and let the market dish out the losses to those who bet against it. Which is what happened.

[Nick Rowe]

Determinant: given the time you spend reading this blog, you are a very unrepresentative member of the general public ;-).

My usual assumption is that central banks target inflation, which means both causing target inflation and reacting to above or below target inflation. I'm less sure about the Fed, but then so is everyone else.

[Nick Rowe]

Determinant: "I can assume that, but the game itself is rational and a rational player will always win against an irrational player."

Not true in all games, unfortunately. The strategy "Do what I want or I will blow up the world!" does very well in many games against rational players who know you are irrational. (It's only when that irrational player plays another like himself that he does badly).

"No it doesn't to listen to them. Facts win over fools."

The beliefs of others, if they will act on them, are a fact, even if (especially if) those beliefs are irrational.

[Adam]

Does it have to be "too loose?" Can't it be "appropriate for future growth?"

[Nick Rowe]

Adam: "appropriate for future NGDP growth" would be good. But in the absence of a clear and credible target, expectations will have a wide distribution, and if you knock out those at one tail of the distribution, that will shift the mean.

[Determinant]

The beliefs of others, if they will act on them, are a fact, even if (especially if) those beliefs are irrational.

The beliefs of Very Serious People can be assigned a low credibility as they have consistently shown to be wrong since 2008.

The opinions of Very Serious People who are inflationistas (as all Very Serious People are) have been repudiated by both the market and the general public in its consumption and savings decisions. VSP's lost the experiment. We had a horse race, they bet on the wrong horse and they lost. And they refused to acknowledge that their horse lost.

[RPLong]

Is there any empirical evidence for the view that expectations are the causal factor with respect to inflation? Sorry if that is a dumb question, but I am unfamiliar with this segment of the economic literature. Many economists write about how the key to recovery is in changing inflation expectations.

Maybe that is true - is there any empirical evidence supporting that claim? How do we measure what "expectations" are and then correlate expectations in t0 to growth in t1? Has this been done, and has causality been established within reason?

[Nick Rowe]

RPLong: Definitely not a dumb question.

You need two things to do this sort of empirical test (at least directly):

1. Data on expected inflation. Maybe survey data, or maybe date from the spread between indexed and non-indexed bonds.

2. A data period when expected inflation actually moves around a fair bit. Which means that data from the last 20 years of inflation targeting in Canada is pretty useless, because the Bank of Canada has been trying very hard, and mostly succeeding, to keep expected inflation "well-anchored at the 2% target". I.e., the Bank of Canada has been trying to make sure the data doesn't do what you need it to do to give a good empirical test.

Doing this sort of test was a big thing in the 1970's, IIRC, perhaps for the very reason that expected inflation moved around a lot then, but I don't remember anyone doing it recently, perhaps because the data hasn't moved around much since, or perhaps because everyone simply decided this question was settled. Or perhaps my memory is bad. Does anyone have a better answer?

There are two main channels through which expected inflation will affect actual inflation:

1. Supply-side/Phillips Curve. If you expect everyone else to raise their prices, you raise your prices too.

2. Demand-side. If you expect inflation (for a given nominal interest rate or given nominal money supply) you spend more now, for a given real income, because money will lose its value.

[Min]

Inflationistas need not fear inflation, they can embrace it. :)

[jonny bakho]

Inflationistas do NOT expect higher inflation. Your assumption is incorrect. Inflationistas DEMAND that the FED pursue deflationary- high unemployment- cheap labor policy. They would go ballistic if wage inflation reached 2.5 percent. They don't want wages to rise and more equitably distribute wealth. They are anti-labor.

Inflationistas DEMAND that fiscal policy and the FED pursue high unemployment policy to keep inflation under 2 percent. Even though millions are out of work, even though inflation much higher than 2 percent is needed to reset relative prices they demand inflation that is too low. 2 percent inflation is NOT high enough to drive investment forward.

The inflationistas expect low inflation because they expect to win. Noah Smith is correct to ridicule their position. Ridicule is the correct approach to their non-sense. Inflationistas are winning because they are preventing labor from receiving a share of net income that is more fair.
-jonny bakho

[Nick Rowe]

jonny: OK, you are defining "inflationista" differently from me. By your definition, an inflationista is someone who wants low inflation and high unemployment because they think this will make them richer. "Pensioner" might be a better word for your concept, because I can imagine someone with a safe pension fixed in nominal terms who might want what you say they want.

[Min]

A pensioner on a fixed income may desire low inflation. But that does not mean that he or she desires high unemployment. A better term for those people, at least in polite society, is plutocrat or oligarch. The point is not that they will be richer than they are now, but that they will be comparatively richer than others, and thus wield more power over them. Don't call them pensioners.

[Nick Rowe]

Min: are you sure? A pensioner may want higher unemployment to keep inflation low, plus it makes it easier for her to hire gardeners and home help. It's all a conspiracy by the evil gerontocrats, I tell you!

[Determinant]

Said pensioners care far, far more about their children's and grandchildren's prospects then getting a cheap gardener. Besides, most of them don't directly hire wage labour; so as long as consumer prices are stable they're as happy as clams.

No, no, Min is right, Plutocrat it is. Lately we've been sprouting plutocrats like it's the new Gilded Age.

because I can imagine someone with a safe pension fixed in nominal terms Please provide an example of this purported group. OAS and CPP are indexed, most DB plans are too. The vast bulk of the private sector which doesn't have a DB plan, if they have anything at all, can purchase an indexed life annuity. RRSP holders can choose between well-balanced RRIF which has enough return to cover inflation or purchase an indexed life annuity or both.

The three largest players in the Canadian annuity market, Great-West/Canada Life, Manulife and Standard Life all have indexed annuities. The market got there before the economists did.

[Min]

Nick Rowe: "A pensioner may want higher unemployment to keep inflation low, plus it makes it easier for her to hire gardeners and home help. It's all a conspiracy by the evil gerontocrats, I tell you!"

First, in the US at present, it is unlikely that lower unemployment would generate inflation. There is an awful lot of slack right now. Second, people do not turn into sociopaths when they reach retirement age. Even if they can afford gardeners.

[hix]

Know what those people all have in common, expect being the richest people on earth?

Ah right, they have no bonds, rather they have equity and long term debt. Sure rich people dont like inflation?

nk Name Net Worth Age Source Country of Citizenship
1
Carlos Slim Helu & family
$73 B 73 telecom Mexico
2
Bill Gates
$67 B 57 Microsoft United States
3
Amancio Ortega
$57 B 77 Zara Spain
4
Warren Buffett
$53,5 B 82 Berkshire Hathaway United States
5
Larry Ellison
$43 B 68 Oracle United States
6
Charles Koch
$34 B 77 diversified United States
6
David Koch
$34 B 73 diversified United States
8
Li Ka-shing
$31 B 85 diversified Hong Kong
9
Liliane Bettencourt & family
$30 B 90 L'Oreal France
10
Bernard Arnault & family
$29 B 64 LVMH France
11
Christy Walton & family
$28,2 B 58 Wal-Mart United States
12
Stefan Persson
$28 B 65 H&M Sweden
13
Michael Bloomberg
$27 B 71 Bloomberg LP United States
14
Jim Walton
$26,7 B 65 Wal-Mart United States
15
Sheldon Adelson
$26,5 B 79 casinos United States
16
Alice Walton
$26,3 B 63 Wal-Mart United States
17
S. Robson Walton
$26,1 B 69 Wal-Mart United States
18
Karl Albrecht
$26 B 93 Aldi Germany
19
Jeff Bezos
$25,2 B 49 Amazon.com United States

[Bob Murphy]

Nick,

Next post you should model someone who is really really smug and annoying when he criticizes inflationistas, to see what marginal impact he or she would have. Just in case that should ever happen in real life.

(In case people are confused, I'm not referring to Nick.)

[Determinant]

So pray tell, Bob, what is the marginal impact of Krugman who publishes in the New York Times and Noah Smith, who has a column in the Atlantic Monthly?

[Tom Brown]

"Noah: Doesn't your view imply that the Fed listens more to (say) Neill Ferguson than it listens to people like you, Paul, and Brad? And that it's the other way around for the rest of the general public?"

But it's not just Neill, it's Allan Meltzer, Martin Feldstein, John Taylor, John Cochrane, and the WSJ editorial page... and then the usual lunatics: Ron Paul, Rick Perry, Rand Paul, Peter Schiff, Alex Jones, Glenn Beck, Mark Levin, ... then the "well maybe not inflation, but the 'central planners' are destroying America anyway and have to be stopped!" crowd: people like Steve Forbes and David Stockman... and Mish Shedlock. Throw in ZeroHedge, ShadowStats, Chris Whalen... and you truly have a toxic brew.

Also, somehow your inside vs outside inflationista concept seems very anti-EMH. I'm not sure Scott Sumner would approve. Tsk Tsk!

[Tom Brown]

Plus many in that crowd, if they see inflation coming, they see HYPER-INFLATION coming! You know.... the END times! They're going to put it ALL into gold bars, ammo, gold bars, dry goods and gold bars!... and then head to their bunkers... scanning the darkness with their night-vision goggles... waiting to gun down the hordes of savage, desperate welfare queens, food stamp cheats, and fiat money advocates with their handfuls of worthless government script! No room for pity... those fools were warned... they didn't understand that inflation means "time to SAVE!... time to save GOLD! Who's laughing now?!... take your ridiculous paper money and GET OUT!! Blam blam ... blam blam blam! Get off of my property you worthless profligate unbelievers!"

Just ask Peter Schiff, Alex Jones, Glenn Beck.... or David Stockman... Ha!