I think the deflation problem is with Government created money vs free banking money. People trust Government too much and so in a downturn the try to accumulate Government money but with free banking, fearful people will try to spend bank money and not hold it.
I've always read "fighting inflation" as "fighting high inflation." Central banks the world over are very open about their inflationary goals: keep inflation low (i.e., 2-3%) and stable. In reality, inflation is a very minor inconvenience when it is kept low, and people rightfully don't care (except Austrians).
With this in mind, calling the FED's fight against inflation propaganda seems overblown.
1: It isn't clear to me why, if productivity is increasing such that deflation is the norm, firms would need to lower real wages. Firstly, real wages would be increasing while nominal wages were fixed. Secondly, productivity increasing so much that prices are going down implies that wages are in the right spot for those firms who are increasing output so much. Some firms might have issues due to not increasing productivity along with the rest, but that's the normal, desirable effect of market competition.
2: Even with low, positive inflation, firms trying to covertly cut real wages compared to their competitors are still relying on their workers not paying attention to what other firms are paying. A few years of 0% raises while other workers are at least getting cost of living (~2-3%) makes it pretty obvious that workers are getting a raw deal if they are looking around. Granted, they might not be paying attention, but then it is strange to think they are paying little attention to small percentages while working and all the attention while unemployed, which is what the deflationary issue hinges on.
3: Akerloff et al. probably shouldn't be calling their model a "simulation" considering they are using representative agents (firms), fixed productivity ratios, and one type of worker only. The first two are really damning, as all of their shocks are entirely exogenous therefore, and not due to some firms expanding or contracting based on their productivity.
Unless I am wildly misreading what their model does, they essentially made up a model that shows what outcomes they want, as opposed to starting with a model of reality's relevant parts and seeing what happens. There is no reason to take the outcomes of their simulation seriously, because the mechanics of their simulation don't cleave to the underlying reality they are trying to mirror.
Ignorantly asked...are there now other creators of Money? At one point the total "value" of cryptocurrency appeared to be around 3 Trillion dollars. Was this an inflationary creation? This seems to be a corollary to the "wealth effect". Are the enormous increases in "equity" in the home and equity markets also a psychologic equivalent to money ( they can be spent) which feed through to greater demand?
But would that be true in a world with deflation? Or would people be better to adapt, because the would know that inflation wasn't going to "fix the problem" sooner or later?
When it comes to the more or less undeniable phenomenon of people requiring larger homes, more advanced technology and more stuff in general to attain the same level of subjective satisfaction as compared with the past, is this an example of "increased demand" (on an objective metric), or "not necessarily increased supply" (on a subjective metric)?
Very interesting. I wasn’t familiar with the specifics of your economic thought so this actually surprised me. I’m curious what your preferred monetary policy would be.
"But isn’t the free-markets’ built-in deflationary tendency dangerous? Hard to be sure, but likely yes."
Can you say a bit more about that? It seems to me there is something going on that I never understood about monetary policy (despite reading about it many times ...)
The fed fights high inflation (more than 2% annually). Moderate inflation is very good. Deflation means misery and maybe repeat of Hitler, holocaust and world war.
Why didn't Hitler arise in 1800-1914, when we literally had overall deflation that entire time?
I agree that a repeat of the Great Depression could cause some problems, but we had big deflation bouts in the early 1920s and we call it the booming 20s.
Its pretty clear that our current monetary policy is "target 2% but every ten years decide there is a crisis that allows us to break all the rules".
Usually supply is growing, but on rare occasions there is a constriction, which causes prices to rise. Under such circumstances the Fed can, indeed, "fight inflation," by reducing the money supply. But, actually, this is when the Fed should be least hawkish, and should allow the market to respond to the reduced supply with higher prices.
If the Fed hadn't supported the economy when during COVID, politicians would have been forced to end the restrictions they implemented to reduce supply. Nobody would have put up with stay at home if they weren't getting paychecks for not working.
The only reason the Fed got away with it is that demand was also restricted, so people sat on the money and first but eventually it ended up in the economy causing the current inflation.
By enabling fiscal authorities bad choices they are deeply responsible for how this turned out.
The money supply has been massively increased since 2008 in most large economies. Sure, Covid spending contributed, but it's not the only cause of current inflation.
Back in the gold era, wouldn't the deflationary pressure lead to more gold being mined, leading to an increase in the monetary supply? And is that why, subject to big fluctuations, the long term inflation rate was roughly zero?
The more valuable gold becomes, due to deflation, the more gold becomes cost effective to extract, which then lowers the value of gold, creating an equilibrium (albeit, a wobbly one).
That equilibrium only holds if there are huge known gold reserves with a stable cost of extraction. But if known reserves start getting closer to their limit extractable at a certain price, or if new reserves with easy extraction are discovered, then you get outside shocks to the monetary supply.
I want the Scott Sumner response to this framing.
I think the deflation problem is with Government created money vs free banking money. People trust Government too much and so in a downturn the try to accumulate Government money but with free banking, fearful people will try to spend bank money and not hold it.
I've always read "fighting inflation" as "fighting high inflation." Central banks the world over are very open about their inflationary goals: keep inflation low (i.e., 2-3%) and stable. In reality, inflation is a very minor inconvenience when it is kept low, and people rightfully don't care (except Austrians).
With this in mind, calling the FED's fight against inflation propaganda seems overblown.
Good essay. A few points:
1: It isn't clear to me why, if productivity is increasing such that deflation is the norm, firms would need to lower real wages. Firstly, real wages would be increasing while nominal wages were fixed. Secondly, productivity increasing so much that prices are going down implies that wages are in the right spot for those firms who are increasing output so much. Some firms might have issues due to not increasing productivity along with the rest, but that's the normal, desirable effect of market competition.
2: Even with low, positive inflation, firms trying to covertly cut real wages compared to their competitors are still relying on their workers not paying attention to what other firms are paying. A few years of 0% raises while other workers are at least getting cost of living (~2-3%) makes it pretty obvious that workers are getting a raw deal if they are looking around. Granted, they might not be paying attention, but then it is strange to think they are paying little attention to small percentages while working and all the attention while unemployed, which is what the deflationary issue hinges on.
3: Akerloff et al. probably shouldn't be calling their model a "simulation" considering they are using representative agents (firms), fixed productivity ratios, and one type of worker only. The first two are really damning, as all of their shocks are entirely exogenous therefore, and not due to some firms expanding or contracting based on their productivity.
Unless I am wildly misreading what their model does, they essentially made up a model that shows what outcomes they want, as opposed to starting with a model of reality's relevant parts and seeing what happens. There is no reason to take the outcomes of their simulation seriously, because the mechanics of their simulation don't cleave to the underlying reality they are trying to mirror.
(The links to the Akerloff et al. paper, as well as the insider/outsider model in your previous post, no longer seem to work. I found the paper here https://www.brookings.edu/wp-content/uploads/1996/01/1996a_bpea_akerlof_dickens_perry_gordon_mankiw.pdf.)
Ignorantly asked...are there now other creators of Money? At one point the total "value" of cryptocurrency appeared to be around 3 Trillion dollars. Was this an inflationary creation? This seems to be a corollary to the "wealth effect". Are the enormous increases in "equity" in the home and equity markets also a psychologic equivalent to money ( they can be spent) which feed through to greater demand?
Can you elaborate on demand being "roughly stable"
You write "Nominal wage rigidity is both strong and durable." (here: https://www.econlib.org/archives/2013/04/the_grave_evil.html)
But would that be true in a world with deflation? Or would people be better to adapt, because the would know that inflation wasn't going to "fix the problem" sooner or later?
When it comes to the more or less undeniable phenomenon of people requiring larger homes, more advanced technology and more stuff in general to attain the same level of subjective satisfaction as compared with the past, is this an example of "increased demand" (on an objective metric), or "not necessarily increased supply" (on a subjective metric)?
Very interesting. I wasn’t familiar with the specifics of your economic thought so this actually surprised me. I’m curious what your preferred monetary policy would be.
"But isn’t the free-markets’ built-in deflationary tendency dangerous? Hard to be sure, but likely yes."
Can you say a bit more about that? It seems to me there is something going on that I never understood about monetary policy (despite reading about it many times ...)
The fed fights high inflation (more than 2% annually). Moderate inflation is very good. Deflation means misery and maybe repeat of Hitler, holocaust and world war.
Why didn't Hitler arise in 1800-1914, when we literally had overall deflation that entire time?
I agree that a repeat of the Great Depression could cause some problems, but we had big deflation bouts in the early 1920s and we call it the booming 20s.
Its pretty clear that our current monetary policy is "target 2% but every ten years decide there is a crisis that allows us to break all the rules".
Since contemporary Hitler is going to have nuclear weapons, letting deflation persist may mean end of human existence.
There isn't going to be a contemporary Hitler.
Putin derives his power from the memory of the economic collapse of the nineties.
Usually supply is growing, but on rare occasions there is a constriction, which causes prices to rise. Under such circumstances the Fed can, indeed, "fight inflation," by reducing the money supply. But, actually, this is when the Fed should be least hawkish, and should allow the market to respond to the reduced supply with higher prices.
If the Fed hadn't supported the economy when during COVID, politicians would have been forced to end the restrictions they implemented to reduce supply. Nobody would have put up with stay at home if they weren't getting paychecks for not working.
The only reason the Fed got away with it is that demand was also restricted, so people sat on the money and first but eventually it ended up in the economy causing the current inflation.
By enabling fiscal authorities bad choices they are deeply responsible for how this turned out.
The money supply has been massively increased since 2008 in most large economies. Sure, Covid spending contributed, but it's not the only cause of current inflation.
Fed = socialism for the rich
Back in the gold era, wouldn't the deflationary pressure lead to more gold being mined, leading to an increase in the monetary supply? And is that why, subject to big fluctuations, the long term inflation rate was roughly zero?
The more valuable gold becomes, due to deflation, the more gold becomes cost effective to extract, which then lowers the value of gold, creating an equilibrium (albeit, a wobbly one).
That equilibrium only holds if there are huge known gold reserves with a stable cost of extraction. But if known reserves start getting closer to their limit extractable at a certain price, or if new reserves with easy extraction are discovered, then you get outside shocks to the monetary supply.
It's not quite clear what your mean when you say that aggregate demand would stay roughly stable without the Fed's intervention.
What alternative arrangement do you have in mind?
I can believe that free banking and competitive note issue (and no legal tender) would produce roughly stable nominal spending.
But I don't think that's what you had in mind?