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A discussion of "Inflation"

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    I'd like to start a discussion in inflation. I wrote something long and boring up, but I'd rather get a conversation going.

    So I'll start it and see if it takes us anywhere....

    The word inflation gives us a clue as most of us know intuitively, to inflate is to make larger. Strictly speaking, inflation is a rise in the aggregate price level for a sustained period, usually about 6 months.

    It’s also pretty obvious that when prices rise that it takes more money to buy the things we want.

    What is the cause? Why does the value of money decline? And more importantly, what is the solution to periods of high inflation.

    The most common explanation for is that inflation is said to be "too much money chasing too few goods", when explained this way, it makes it sound as if money is the problem, but if I explain inflation as "not enough supply to meet demand. When explained this way the problem seems to be one of lack of supply rather than a surplus of money.

    How we define the cause influences how we solutions.....

    Thoughts?
  • Liberal Democrat
    Democrat
    Colorado Springs, CO
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    An interesting topic. I'll provide some random thoughts that are not necessarily related.

    Overall, I would say that in the United States, inflation is largely demand driven. When demand exceeds supply, prices rise.

    The official inflation rates are measured on an annual basis by the Bureau of Labor Statistics. They have various indices of Consumer Price Index (CPI) that measure the annual changes in a basket of goods and services used by consumers with weighting factors applied to each component.

    The change in demand will be reflected in the costs, either up or down. The weighted average from year to year is the official inflation rate.

    However, it does pose some questions. Take the cost of higher education, for example. Everyone agrees that the cost of higher education has gone up year after year for many years. So one would say that this sector of the economy has experienced more inflation than the average. But is it true inflation or rather a shifting of costs? With state and federal governments cutting subsidies to these institutions, the shortfall in revenue is largely made up by raising tuition costs for students. And as long as there as guaranteed government loans to the students (or alternatively parents dipping into their savings), the demand remains high, even as tuition costs rise.

    There are other factors involved, but I think as long as demand remains high, there is little incentive for these institutions to control costs. The victims, of course, are the poor students who have to take out loans.

    Nevertheless, the bottom line cost of education, year to year, is a part of the basket of services included in the CPI. The offsetting lower taxes on those consumers are not reflected in the CPI.

    On the other hand, housing is one of the largest components of the CPI, and there are large regional differences. In viewing the various components of the housing costs, property taxes do not appear to be included for house costs; however, renters costs likely are inclusive of those taxes. Many cities like mine have made up for cutbacks in government subsidies by imposing higher property taxes on home owners. Those higher taxes are not reflected in the CPI.

    Putting those tax issues aside, however, demand is still probably the largest driver of inflation in the housing sector.

    There are of course other issues...some of them molehills made into mountains by the media. One particular point I have brought up repeatedly in this website is that the CPI-W (or rather the three month period, July to September) used to determine cost of living raises in Social Security benefits is archaic and needs to be converted to average annual costs. I am an advocate for the chained CPI (C-CPI-U) but populist rhetoric and misinformation have made this a political hot potato.

    With regards to skills, manpower supply, and unemployment, as long as there is high unemployment or underemployment, inflation will also be low. When we achieve full employment, whatever that is, than we can expect wage inflation to rise again.

    Finally, I don't think that monetary policy has had as much effect on inflation in the United States. Certainly exchange rate fluctuations can cause the cost of imported goods and services to change and these would be reflected in the annual CPI indices. However, our country has had relative economic stability compared to Venezuela where a combination of bad monetary policies and collapsing oil prices have brought chaos to the economy.

    Just some thoughts to stimulate discussion.

  • Strongly Liberal Democrat
    Democrat
    Pensacola, FL
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    The effect on aggregate demand of money concentrated at the upper end of the income gap? Exceeds any social comment on large wealth. It seems that concentration of wealth effects all forms of economics. The effect of trading goods and services by reducing and accelerated reducing amount of money. In math variables changing linearly or nonlinearly produce new results. Math extrapolation can predict results. Social extrapolation produces Trump and Sanders. Denial trumps logic. Just as 2008 was totally obvious it was denied. ???
  • Liberal Democrat
    Democrat
    Colorado Springs, CO
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    I don't understand what this has to do with the discussion of inflation. Or maybe I just don't understand what you are saying at all.
  • Strongly Liberal Democrat
    Democrat
    Dallas, TX
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    The government is a price setter at the margin, not a price taker per se. It's a monopolist of its currency. Monopolists don't take prices; they set them. Additions and subtractions of government spending in the economy moves markets in substantial ways. Price takers do not have that capacity by definition. So this not a point up for mainstream economic debate, and not something that only MMT'ers recognize.

    .........

    With DoE student loan lending, government is validating prices paid by student borrowers who have little ability to negotiate prices on their own in an imperfect monopolistic market place. So from a mainstream perspective, that entire situation is a problem from an efficiency standpoint on the cost of education side of things. Meanwhile, it's a huge issue threatening the broader credit expansion in the economy, which is not controversial in mainstream economic debate, and not something that only MMT'ers recognize.

    .........

    Social Security needs to be expanded for public purpose. Every American deserves to retire with dignity. As such, there needs to be broad public discussion on increasing Social Security benefits and cutting payroll taxes. That is the starting point of the discussion to "save" Social Security from a "Progressive" point of view. So I'm hostile to anything that does not substantialy raise real benefits for most retirees and cut payroll taxes for working people. In regards to Social Security benefits, the trick is keeping Social Security benefits at levels that make us proud to be Americans, as Warren Mosler has explained. That's somewhere between retirees having the purchasing power to fly into Superbowl luxury suites and having a hard time making ends meet. Both extremes would make most of us embarrassed to be Americans.

    ........

    It is possible to have inflation and unemployment, but the government budget balance has nothing to do with it. Inflation is always about the prices paid for output, not about dollars net-saved. Inflation is about spending in the economy vs supply of real stuff; not the government budget deficit.

    Government can do a whole lot of crazy shit with fiscal and monetary policy, as well as the broader institutional structure, that could cause both unemployment and inflation at the same time.

    Meanwhile, there are other monopolists to worry about, such as the Saudis, who have the largest swing capacity to produce oil and are not exactly subject to US regulation for public purpose.

    .......................

    Monetary policy does effect prices, but in the opposite way then the mainstream appears to assume.

    Higher interest rates are associated with higher rates of price inflation, not lower.

    Lower interest rates are associated with lower rates of price inflation, not higher.

  • Independent
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    carlitos, perhaps you can explain why volcker allegedly "broke the back of inflation" when he raised rates in the '80's in response to inflation.

    on a side note mrs. bird and i bought our first house in 1986 and we were thrilled to get a flat 10% on a thirty year mortgage. fast forward to 2014 and we refinanced the house we live in now to a 10 year mortgage at 2.75%. interesting.

  • Strongly Liberal Democrat
    Democrat
    Pensacola, FL
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    Schmidt Wrote: I don't understand what this has to do with the discussion of inflation. Or maybe I just don't understand what you are saying at all.

    Schmidt, The discussion is inflation. A driver of inflation is aggregate demand. In the last 15 years the economy has changed so much that that old rules must be assigned to historical discussions in the parameters of the particular period. Derivatives are relegated to non conversational. Consider that the husband of your candidate was influenced enough by somebody to sign into law a new expansion of and laws mitigating gambling and oversight on derivatives. That was no accident and it is not accidental that derivatives are becoming the actual market. Inflation is directly influenced by the amount and velocity of money. Derivatives are creating a new inflation because money is not being restricted by interest rstes. Contrarily iinterest rates are so low that inflation and GDP should be accelerating. But they are not because the huge amount of money in trading is not financing industrial growth. In fact it is not growth at all but stagnation. I don't understand the dismissive attitude towards the largest accumulation of money doing nothing.

  • Independent
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    the only driver to inflation is greed/fear. if demand increases we are told by classical and neoclassical economics then prices increase. why? demand itself cannot drive prices up. only a human response in the form of "more people want my goods/services therefore i will raise my prices" can cause prices to rise. were the supplier of goods and services simply to maintain his prices he would make profit just as he did prior to there being a higher demand. higher demand leads to want for higher profits aka greed. increase in money supply has been pointed out as causing inflation. this again is inaccurate. human response raises prices. in the case of money supply such response may be based upon fear of hyperinflation. yet as yves smith notes in her book in some instances increasing prices actually increases demand as opposed to the other way around. the human response becomes one of getting a perceived better product a form of greed even if it not the case. greed/fear hits a wall as the late crisis points out. when the opaque instruments became unwanted due to housing prices plateauing and then dropping no price could be low enough. fear set in. it is a self-reinforcing feedback loop that eventually must collapse.
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    lonely bird Wrote:

    carlitos, perhaps you can explain why volcker allegedly "broke the back of inflation" when he raised rates in the '80's in response to inflation.

    on a side note mrs. bird and i bought our first house in 1986 and we were thrilled to get a flat 10% on a thirty year mortgage. fast forward to 2014 and we refinanced the house we live in now to a 10 year mortgage at 2.75%. interesting.

    If you don't mind I'll take a poke at this....

    In economics the financial system utilizes double entry accounting. That is, for every transaction there are two entry's when accounting. Assets and Liabilities. I'm certain you already know this, so consider this a reminder for those that might not know that.

    Similarly, you can attack most fiscal issues from more than one side.

    In an economy experiencing inflation, you can attack the problem by raising interest rates which in turn reduces spending (as Volker did) or you can increase production and or costs in order to drive prices down on whatever it is (in this case oil), or offer lower priced alternatives, though admittedly reducing costs and creating alternatives takes time. Volcker's approach was in my opinion, a very blunt solution to the problem as it didn't target the areas of the economy that were causing prices to rise.

    In the end the value of the dollar was considered more important than the suffering people endured during that same period. Unemployment hit a peak of 11% and industries that relied on finance were hit hard, especially banking.

    Of the top of my head, what if the government had some how subsidized costs for higher fuel costs (perhaps a tax credit) for 3 years and carried the liability on it's balance sheet, while at the same time funding research to lower consumption, increase supply, and create incentives for alternatives.

    Because the inflation of the 70's was largely cost driven, helping the average family maintain that cost would have prevented the inflation that followed.

  • Liberal Democrat
    Democrat
    Colorado Springs, CO
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    Okay there are several good points here that I will comment on:

    Chet – I certainly understand full well that aggregate demand is a driver of inflation. But what you were talking about was aggregate demand of money concentrated at the upper end of the income gap, followed by some analysis that I just couldn’t follow. Your second post clarifies that you see derivatives, your favorite topic, as the driver of inflation. I think there are other factors that are more prominent drivers of inflation. Are you making a mountain out of a molehill?

    Carlitos – Government monetary policy certainly can have an effect on inflation, but I haven’t seen that it has had a large effect, at least not recently. The official CPI inflation rates have been relatively low the past couple of decades, except for 2008 when it reached, 3.8 percent…the year that oil prices also peaked at an all-time high of US$147.27 in July of that year. In the last seven years since 2008, inflation has averaged 1.4 percent. We’ve had quantitative easing, and low interest rates. However, are not the Federal Reserve’s policies of setting of low interest rates a function of the low inflation rates, which in turn are driven by low demand caused by relatively high unemployment and low wages…not to mention low oil prices? It really depends on what you see is the cause and effect. Are the Federal Reserve policies on low interest rates a reaction to the economic factors; or are they affecting the economy and therefore influencing the low inflation rates? I think the former.

    With regards to the cost of college tuition, I take your point that government is validating prices paid by student borrowers who have little ability to negotiate prices on their own in an imperfect monopolistic market place. That is true. But underlying the whole mess in student debt is the demand for higher education, something that has been pushed by Obama, Sanders, Clinton and others as a necessity to compete in the new reality of globalization. Also driving demand is the coming of age of the children of the baby boomers. Without government guaranteed or subsidized loans, the demand would still be there, and costs would be covered by parents dipping into their savings or taking out new mortgages on the houses or private loans. And also students having to work their way through college, something that is increasingly difficult and extends the time they are captive in that academic environment.

    On Social Security, as you know Social Security benefits have been indexed to inflation, the CPI-W, since 1984. The Old-Age, Survivors, and Disability Insurance (OASDI) benefits have risen every year with inflation, and until recently, it hasn’t been a big issue for retirees. I have bolded the word, “insurance”. The OASDI was never intended to provide for 100 percent of a retiree’s need after retirement. The underlying assumption was that it would augment one’s retirement pension income and savings. When my Dad retired from working in the mines, his gross retirement income (pension plus social security) was quite adequate for their needs, but they were also quite frugal with their money having grown up during the Great Depression years.

    What has happened is that many retirees and people wanting to retire have seen their life savings and pensions wiped out during the Great Recession, or maybe they were less frugal during life, or maybe took too many risks with their savings, or maybe they had major medical expenses…or maybe they had to spend it on the children’s college education costs. Whatever the reason, many politicians are wanting to change Social Security into something it was never intended to do: provide for 100 percent of a person’s lifestyle needs in retirement. That’s fine, but let’s call it that…a bail-out of sorts. We bailed out the banks and the auto industry, so a bail-out for those underwater with debt and no chance of recovery would seem to be in order. Social Security has worked fine for many Americans including my parents until now. Ditto for me and my wife. The fact that it is being asked to do much more is a game changer. So for those so affected maybe we need a whole new bail-out program to help them out, but let Social Security work the way it was intended.

    I agree with your other points. I’ll quit as this is another long post.

  • Strongly Liberal Democrat
    Democrat
    Pensacola, FL
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    "Whatever the reason, many politicians are wanting to change Social Security into something it was never intended to do: provide for 100 percent of a person’s lifestyle needs in retirement."

    The game has changed. Wealth is being created without people and without working (derivatives). College educations are becoming worthless. It is not a case of the successful succeeding and protecting their wealth. It is a case of the successful denying the inevitability of an exclusive concentration of wealth.

  • Strongly Liberal Democrat
    Democrat
    Dallas, TX
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    Schmidt Wrote:

    However, are not the Federal Reserve’s policies of setting of low interest rates a function of the low inflation rates, which in turn are driven by low demand caused by relatively high unemployment and low wages…not to mention low oil prices? It really depends on what you see is the cause and effect. Are the Federal Reserve policies on low interest rates a reaction to the economic factors; or are they affecting the economy and therefore influencing the low inflation rates? I think the former.

    Both. Fed lowers/raises rates when they see the economy cooling off/heating up. Those actions and statements further confirm general views of existing economic conditions. The problem is the reactions don't work according to plan.

    When the Fed lowers rates, the immediate effect lowers the net-interest income earned by the economy's savers.

    Some of that net-interest income would be spent, so this is a negative for aggregate demand.

    Assuming 'neutral' government fiscal policy, new borrowing has to make up for that lack of spending just to get total spending in the economy back to even and go further than that to add to total spending.

    Cost of funding will go down and add to the spread of lenders first before their borrowers see lower interest rates at the 'retail' level. If the lenders are paying out those profits to employees or putting those profits to use in the form of investment spending, that could be a source of new spending regardless if borrowing increases; but most likely it won't alter spending much, as firms may need those funds for to do their normal spending if they are distressed, or if not, the funds end up in the corporate demand leakages.

    So all that goes on before the interest rate cut has a chance to influence borrowers.

    Meanwhile, interest rates are one of many factors in the decision to borrow to spend for whatever purpose.

    I'm not saying that Fed interest rate changes have the same unambiguous effect regardless of other economic conditions or factors. But with the economic conditions or factors that we have, their effect is the opposite of their intent.

  • Strongly Liberal Democrat
    Democrat
    Dallas, TX
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    lonely bird Wrote:

    carlitos, perhaps you can explain why volcker allegedly "broke the back of inflation" when he raised rates in the '80's in response to inflation.

    on a side note mrs. bird and i bought our first house in 1986 and we were thrilled to get a flat 10% on a thirty year mortgage. fast forward to 2014 and we refinanced the house we live in now to a 10 year mortgage at 2.75%. interesting.

    Jimmy Carter's deregulation of natural gas and other energy efficient reforms broke the OPEC driven 70s inflation, not Volcker. The higher interest rates in the 70s only prolonged the inflation.

    Aggregate demand measured by GDP below took a beating and inflation measured by CPI still chugged along.

    It would be helpful if the graph immediately below also included a long term rate to indicate where the yield curves are inverted, but you can infer from the graph below it.