In a “must read” post, Scott Sumner turns the popular notion of “inflation” on its head.

Here’s Scott:

…I’m a philosophical pragmatist, happy to live with fuzzy concepts that are useful.  The problem is that [the term] inflation isn’t even useful, as whenever people talk about inflation they are actually talking about something else.

1.  Does inflation impose a tax on capital?  No, rising nominal returns on capital impose a tax on capital.  And those are caused by faster NGDP growth (and rising levels).

2.  Are eurozone officials correct when they say inflation hurts consumers?  No,supply shocks hurt consumers, and if the ECB prevents the supply shock from leading to inflation, consumers will be hurt EVEN MORE THAN IF PRICES DO RISE.  The harm to consumers has NOTHING TO DO with prices rising.

3.  Does inflation lead workers to demand higher wages?  No, rising NGDP leads workers to demand higher wages.

If you are talking about inflation, you are talking about the wrong variable.

This: “No, supply shocks hurt consumers, and if the ECB prevents the supply shock from leading to inflation, consumers will be hurt EVEN MORE THAN IF PRICES DO RISE.”

I’d add that if ANY CENTRAL BANK prevents a negative supply shock from leading to inflation, consumers will be hurt even more than if prices do rise; and it leads to a global catastrophe when most all of them do it at the same time – like in 2006-2009 during the negative oil supply shock.

Pushing the price level down during a negative supply shock results in a double-whammy – shrinking nominal income in addition to the bite into the wallet from higher energy prices. The dominoes start falling at the marginal and it works its way up as wage rigidities cause unemployment to rise.

Under inflation targeting, this scenario is business as usual because reasoning from a price change is codified into policy. The Fed does not care why prices rise, only that they have. And as mortgages are defaulted, bureaucrats in government, especially at the Fed, attempt to lay blame elsewhere such as on people using their homes as ATM, greedy, reckless banks, and so on. It’s all bull crap from the start.

Henry Paulson lied to Congress about the cause of the financial crisis when he described a condition of nearly everyone in the nation being irresponsible and reckless. He may not have lied intentionally, but it was not the truth. The entire crisis and lengthy recession was made and prolonged at a famous building with Greek columns on Constitution Avenue – and the Fed has gotten away with it without changing one darned thing.

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