Minyan Mailbag: Inflation
My head hurts!
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.
Read (and re-read) your thread on inflation/deflation with much interest. Very enlightening...thanks. A few questions related to your exchange.
1) How to define inflation/deflation? If I were to ask the following multiple choice question to my students:
Inflation is defined as:
a) An increase in the consumer price index (probably the most pervasive definition out there today)
b) An increase in the price of anything (goods, services, stocks, bonds, real estate, etc.)
c) A decline in the purchasing power of a currency
d) A reduction in the desire to hoard cash
e) An increase in money and credit (classic Austrian definition)
I think I'd need to include an "all of the above" alternative as definitions a) thru e) have all been empirically offered, no?
2) If I'm understanding the Austrians correctly, they model inflation as cause rather than effect. For example, inflation (defined as an increase in money and credit) CAUSES prices to change. But there are a lot of price categories that could be affected (goods, services, stocks, bonds, real estate, commodities, etc). If you buy the general Austrian model (fair disclosure: I do), then do we know with high confidence the sign (positive or negative) of the relationship between credit increase and various price categories? Plausibly, couldn't an increase in money/credit drive price levels of some categories (e.g., stocks, bonds) higher while causing little or perhaps even negative changes in other price categories (e.g., consumer goods, pm's)--at least for some significant period of time (related perhaps, to behavioral variables)?
3) Scott, near the end of your thread, you alluded that hyperinflation follows deflation 'as night follows day.' Admittedly, I need to do more study of economic history. First, I probably need a clearer idea of just what 'hyperinflation' is (there's that definition thing again). Second, is there a historical pattern of deflation-then-hyperinflation? Seems counterintuitive to me, as I would have thought that hyperinflation (perceived by me as rapid percentage increases in prices) preceeds a period of generally (and prolly significantly) declining prices. How does your view jibe with the 1920/1930 period in U.S. economic history?
4) One more for you, Scott. You mention that "The deflationary forces of this particular kondratieff cycle have been in place for more than 15 years now." But ascribing to the Austrian view, I perceive mostly "inflationary forces" in motion (massive money/credit increase) since the early 1980s. What am I missing?
Thx again to both of you for all you do for the 'Ville.
1) How to define inflation / deflation?
Yes, each of those has been offered as definitions and each gives some nod to either the cause or the effects of said inflation. I would think that something general like: "an increase in prices" would suffice without having to go into the the why's or hows of said increase. Such 'counting of angels on heads of pins' as detailing the semantics of inflation is what makes economics the dismal science (but I digress).
2) Austrian definition of inflation.
You said: "If you buy the general Austrian model (fair disclosure: I do), then do we know with high confidence the sign (positive or negative) of the relationship between credit increase and various price categories? Plausibly, couldn't an increase in money/credit drive price levels of some categories (e.g., stocks, bonds) higher while causing little or perhaps even negative changes in other price categories (e.g., consumer goods, pm's)--at least for some significant period of time (related perhaps, to behavioral variables)? "
That relationship - between an increase in money/credit and the resulting increases in goods/services/assets inflation - is a potentially great but ultimately unknowable relationship. Or at least I have not seen any rigorous studies completed suggesting such a neat linear relationship exists. Which makes sense: after all, each economic cycle is different. Any perturbation in credit/money would tend to have its own unique response for each economic cycle based on how advanced the capital stock is, what regulations are in effect, what the productivity of labor is, etc. Maybe earlier in the century a large increase in money/credit resulted principally in higher labor costs while asset prices did not increase as much. Perhaps the last 20 years have seen that relationships switch: labor costs remain muted but asset prices have skyrocketed. I don't know, I am speculating. The exact effect of said increase is not important to understand the Austrian-inspired mechanism at work: higher prices on net for the economy.
But you allude, intuitively, to behavioral aspects in the deflation/inflation debate in that question, and I have my own bias as to its role. Indeed, I think this is a weakness of Austrian understanding of inflation. Specifically, Austrians believe that inflation is always and everywhere a monetary phenomenon. That it is the presence of excess credit alone that leads men to reduce their time preferences, engage in riskier business ventures with longer payback horizons, to speculate in land or equity investment, etc. And while such an assertion is manifestly more 'right' than the Keynesian tripe that inflation is simply a price phenomenon wholly unrelated to the amount of credit available with which to engage in said time preference shifting, it still seems, to me, a touch incomplete. I for one believe that inflation and deflation has important psychological aspects that cannot be ignored. Yes, fiat currency regimes make it easier to speculate, they do incent consumption over saving and generally favor debtors over creditors. But for every lender there must be a borrower. And no matter how much money is available to lever up to purchase a home, to produce yet another semi fab in southeast Asia, or to spend retirement savings on a flat screen TV, the borrower and lender of that money still need to have the risk-taking mindset necessary for them to engage in those transactions. So unlike the purely Austrian view that inflation is simply a monetary phenomenon, I believe it is both a monetary and psychological phenomenon, with each aspect providing a greater or lesser degree of effect during any given cycle.
3) Hyperinflation follows deflation as night follows day.
I am exaggerating to make a larger point. Strictly speaking this does not necessarily need to be the case. However, I do believe in balance in natural systems (think sine wave). And the magnitude of the debt creation over the last 50 years generally and 20 years specifically should create a deflation of unprecedented size. On the other side of that deflation I suspect rests an inflation whose size will not be dissimilar to the deflation we are about to undergo. It does not have to happen this way, there are no economic laws that suggest it. But there is an historical pattern of inflation and deflation (and so on and so on), typified by the Kondratieff cycle (and thru different monetary regimes I might add, which bolsters my assertion that inflation is both monetary and psychological).
4) I perceive mostly "inflationary forces" in motion (massive money/credit increase).
Yes, credit and money have been increasing but prices - trended CPI & PPI growth rates- have been falling for the last decade. To be precise, the growth rate of inflation has been falling steadily. Once prices actually start to deflate (and they got remarkably close to doing just that in '01-03), mainstream economists will call it deflation and it will become obvious. But the forces of deflation have been reducing the growth rate of inflation steadily for many years now. The forces are still there, even if the actual price level has only slowed its decrease. My contention is that these deflationary forces (both monetary and psychological remember) are so strong that they barely budged despite the all-time record increases in credit that the Fed put in place from 2001 to present. And now that the Fed is reducing the growth of this credit creation, we will see the forces of deflation come back even stronger than in the 2001-2003 time frame. So net/net, deflationary forces, while nascent 10-15 years ago, have steadily picked up steam ever since. The great reflation of 2001-2005, will turn out to be, in my opinion, merely a cyclical reflation effort within a secular deflationary regime. It will fail (my models are suggesting it is already turning) in time and produce a serious deflation in all areas: assets, goods, commodities, and services.
Hope that helps.
Thx much for your replies...outstanding thought food (as usual).
The researcher in me craves empirical study that examines price behavior of various categories (goods, services, stocks, bonds, real estate, commodities, etc) during some of the 'famous' inflationary and deflationary periods in economic history. For example, would love to have a complete set of categorical price series (with monthly or quarterly data points) for:
a) German Wiemar early 1920s
b) U.S. 1920 thru 1930s
c) Japan 1980 thru 1990s
d) Brazil/Argentina (1990s)
A measure or two of credit/money in each would be nice too.
The best work I've read along these lines was Anderson's (1949) study of b), but even that left me longing for simple line graphs that displayed time series of various price categories side-by-side.
If you know of such info, would love to be pointed in its direction.
Again, thx for sharing your insight...
The only good work I am aware of on the U.S. experience is that of Murray Rothbard - America's Great Depression - which true to Rothbard's form has a exhaustive bibliography which you would do well to explore. Though I have seen references to Japan's experience in the literature, I know of no analysis of the situation there that takes anything but a purely Keynesian perspective. I suspect a query to the good folks at Mises.org would prove to be helpful in at least getting the data (if not the perspective) you are looking for. I know several of the various Fed banks (Kansas City comes to mind) that have performed studies on the Japanese deflation but alas, that work is flawed from the get-go given their bias.
Good luck in your search Matt and if you find some good sources in your perusal, I would welcome some suggestions to add to my library.
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