Disinflation denial
During the past several years I’ve repeatedly insisted that the huge increase in the monetary base of 2008 would not produce high inflation. I suppose I was naive in thinking that when it became clear that excessively low inflation was the real problem, the inflation hawks would admit they were wrong and re-evaluate their models. I don’t see much evidence of that happening.
One recent theme has been the supposedly unreliability of the core inflation rate, which is now below 1%. Critics (and cartoon bunnies) point to the fact that food and energy are an important part of the average American’s budget. When it’s noted that even headline inflation is barely over 1%, the attention turns to other prices. For instance, Congressman Ryan has recently argued that the Fed should focus on commodity prices. My initial reaction is to say “Yes! Let’s focus on commodity prices! Commodity prices are the best way to tell if money is too easy or too tight.” Think I’m being sarcastic? Then you are in for a surprise.
Before continuing, I’d like to remind readers that in late 2008 you could count on one hand the number of economists (in the entire world) claiming monetary policy was very tight. So let’s take a look at the change in commodity prices in late 2008:
That’s right, commodity price indices fell by more than 50%. That’s Great Depression-style deflation. And where was Congressman Ryan when the Fed was engineering one of the greatest deflations in world history? I don’t recall him or any of the other inflation hawks calling for easier money. But maybe I missed something. If so, I hope my readers will dig up all the stories of conservatives demanding easier money in the fall of 2008. In any case, it’s good to know that whereas back in late 2008 I was almost all alone in viewing money as being extremely tight, I now have the vast right wing conspiracy on my side. Money really was tight in late 2008. And if commodity prices are now the preferred metric of the right, then I’m half way to convincing the economics establishment that I was right all along. Now I just have to convince the left that money was way too tight in 2008. About those near-zero interest rates . . .
BTW, I don’t mean to bash Congressman Ryan, who is from my home state and is one of the best of a bad lot. If all 435 Congressmen and women were like him we’d probably end up with a much more economically sensible tax and spending regime. But I have to say that the conservative movement has recently been grasping for straws on monetary policy. All their predictions are coming in false, and they aren’t drawing the appropriate conclusions.
Update 12/19/10: This post wasn’t well written. I have always felt that commodity prices were one of many useful indicators of whether money is too tight or too easy. But I left the impression that I completely supported a monetary policy that single-mindedly focused on commodity prices. In fact, I’d prefer the Fed look at a wide range of indicators when estimating market NGDP growth expectations, including stock prices, bond prices, TIPS spreads, forex rates, commodity prices, real estate prices, etc. Many commenters correctly pointed out that commodity prices can be an unreliable indicator, and I entirely agree. I got overly enthused trying to show that if it was the right indicator, then money was ultra-tight in late 2008.
Tags: Disinflation
18. December 2010 at 21:33
Watching interest rates lately?
18. December 2010 at 21:55
Scott wrote:
“That’s right, commodity price indices fell by more than 50%. That’s Great Depression-style deflation. And where was Congressman [fill in the blank] when the Fed was engineering one of the greatest deflations in world history? I don’t recall him or any of the other inflation hawks calling for easier money. But maybe I missed something.”
I’ve been pushing this theme a lot recently myself. But I’m honestly overcome with emotion right now. (It doesn’t take much.) Brilliant Scott!
18. December 2010 at 22:47
You don’t have to apologize for bashing Ryan. I think at least half of your readers are neoliberal progressives. (And I feel like neoliberal progressive might be what you mean by “right-wing liberal”).
18. December 2010 at 22:49
Hey Mark, how did the job market come out for you this year? I only know about literature fields, as I am an Adam Smith/eighteenth-century type of scholar. Anyone could put in a good word for me at Dartmouth or Furman? Or could I put in a word for anyone at UNM or Buffalo?
18. December 2010 at 22:58
Shane,
Your asking the wrong person about the job market. I’ve been pursuing the job market in the most inefficient manner possible. I don’t want to leave my beloved house at all. That leaves me with precious little choices. I’ll even settle for a position at Rowan University.
18. December 2010 at 23:05
Professor Sumner,
Can you explain the logic of choosing commodity prices over the CPI or PPI? My assumption is that it most accurately expresses changes in “relative prices” as caused by changes in Ms and Md.
Joe
18. December 2010 at 23:25
Shane,
I’m sorry. That’s not entirely truthful. I may have not applied for positions further away but that’s not because I don’t believe I don’t qualify or that they wouldn’t consider me. It’s that I’m not willing to apply. I have a dandy Job Market Paper that I’m somewhat reluctant to unload.
The fact remains I’d rather live in my house.
Mark
19. December 2010 at 00:37
Muckdog: the answer to your question is yes he is.
Scott: As I understand it, deflation and disinflation both represent increases in the relative scarcity of money. Where they are unexpected, so not reflected in wage and price contracts, they have the same depressive effect on economic activity.
19. December 2010 at 01:02
Scott,
why didn’t you show us the graph starting at 94? (if I am right, yes, I noticed it is a reconstruction)
http://www.jefferies.com/cositemgr.pl/html/ProductsServices/SalesTrading/Commodities/ReutersJefferiesCRB/IndexData/processChart.pl?Index=RJCRB_Total&StartMonth=01&StartDay=01&StartYear=1994&EndMonth=12&EndDay=17&EndYear=2010
So the low starting point was 63.9, is it not? Which means in 17 years to date it gives us almost 10% annual inflation. If we take the lowest point in 2009 of roughly 210 then we get a horrible incomprehensible and growth killing 8.2%. That is because if we take the max of 2006 (forgetting the “excesses of 08”) then we will end up with “normal” 12%+. And BTW, if we take 150-160 as an average for 2002 then we end up with the same 8% to date. So are YOU saying 12%+ is Ok and 8% is dangerously low?
19. December 2010 at 06:20
Scott, the CRB index is up 60% since March 2009, now at 320.62, and higher than it was in August 2007. We also have to keep in mind the nearly 50% rise from August 2007 to June 2008 that preceded the drop you are concerned with.
By the CRB index argument, then, Fed policy was too loose in late 2007 and early 2008, too tight in late 2008 and early 2009, and too loose ever since. And we are having inflation now, and you are in “inflation denial.”
I don’t personally believe these things … but if you reject them, doesn’t that lead to questioning your thesis about late 2008?
19. December 2010 at 06:26
Where in commodity prices does it explain why my grocery bills keep going up every month, while package sizes continue to decrease?
19. December 2010 at 08:17
I can understand why Scott likes commodity prices: they have the advantage of being determined flexibly in highly liquid, highly efficient markets, so they react immediately to changes in expectations. But comments by Joseph and by Paul Jaminet point to the problem with commodity prices: namely, as I view it, that they’re determined in large part by “micro” factors, factors unrelated to inflation. In particular, most commodities are complementary with labor, so the increase in effective world labor supply over the past 25 years (without a corresponding increase in the effective supply of complementary commodities) has induced an increase in the real price of commodities. This might be regarded, though, as a low frequency change and contrasted with the high frequency change depicted in the chart. The market didn’t suddenly realize in late 2008 that the increase in world labor supply was coming to an end (nor was there a sudden discovery of new commodity supply), so the rapid decline was clearly attributable to a fall in aggregate demand. It’s also hard to argue that the rally in early 2008 was caused by an expectation of rapidly rising aggregate demand. After all, we were in a recession. (As I recall, Brad DeLong called the business cycle peak within a month, and he was certainly not the only one who realized that aggregate demand was weak.) More likely it was a recognition that commodity supplies were tighter than previously realized (both in absolute terms and relative to the labor complement). All in all, I’m inclined to conclude that Scott is right: the fact that commodity prices remain far below their 2008 peak is evidence of disinflation.
19. December 2010 at 08:55
Scott,
How can crashing commodity prices signal the Fed is too tight, but spiking commodity prices not signal the Fed is too loose?
Q1: If the Fed had stepped in with an NGDP level target just before Lehman’s failure, what would headline inflation have been in 2009/2010? Would the Fed then have been forced to tighten in 2009? Remember, absent a fall, 2008 NGDP crash, a “level” target would not have a large gap to make up, thus forcing the Fed to tighten sooner.
Q2: If real China growth explained the early 2008 commodity price spike, then how did the August, 2008 Fed meeting signal to traders that they should dump commodities despite Chinese growth? At this meeting, the Fed left the FFR unchanged.
19. December 2010 at 09:07
Scott, you wrote: Before continuing, I’d like to remind readers that in late 2008 you could count on one hand the number of economists (in the entire world) claiming monetary policy was very tight.
Interesting, Here’s my post from Oct 10, 2008 titled <a href="http://ontrackeconomics.blogspot.com/2008/10/2008-federal-reserve-tightening.html"The 2008 Federal Reserve Tightening.
By the way, the point I was making in that post was that while they’d been tight, they had very recently engineered a massive easing:
That post concluded with my comment (referring to the impending payment of interest on excess reserves) “Next, I’ll discuss how our inept government is on the verge of converting the extremely useful “iron bar” to that limp “string” everyone is always talking about. Really. That’s what’s in the works, and it’s important that we understand the implications.”
Oh, and in the post dated December 2, 2008 I forecast that based on that huge money burst referenced above, the turn in the economy would come begin in March of 2009. Note that the April-June quarter was, in fact, the first quarter to experience positive real growth.
I also noted in my last post on that blog, on March 13, 2009, that the economy was starting to turn upwards at that time. I included the following comment:
Interestingly enough, a poll at CNN on when the economy would recover offered no option for “soon” or “now” and only 22% of respondents even chose the “later this year” option. The other 78% are looking for the recession to last until the end of this year at least.
My point in posting all this isn’t to crow. It’s to illustrate that the way I understand the Fed to operate (in the past until very recently at least) does make sense and that if the Fed actually would read my monograph and apply it they would have all the control over the price level that they would need. They could also stop causing boom/bust recessions on a regular basis as they’ve done since the early 1950’s. Unfortunately, that doesn’t seem likely to ever happen.
P.S. Too much html in this one…hope it posts correctly Scott. If it doesn’t, I’ll redo it.
19. December 2010 at 09:12
Well, the link didn’t take. I’ll try again.
The 2008 Federal Reserve Tightening
19. December 2010 at 09:41
Muckdog, Yes, they’re going higher (which is good) but they need to go higher still.
Thanks Mark and Shane, and good luck on jobs.
Yes, I’m a sort of neoliberal. (although all these definitions are vague.)
Lorenzo, Yes that’s right.
Joseph, Your comment does a good job of showing why commodity prices are a very unreliable inflation indicator. They don’t even come close to tracking US inflation, rather they tend to track Chinese RGDP growth.
Congressman Ryan started his look at commodity prices just a few months back. I thought that was too little, so I went a few years back.
Paul, I agree with your comment, see my previous reply. At best, they tell us a little bit about inflation, but there are much better indicators.
Ryan, Are you the congressman? Seriously, inflation is quite low in the US. If you are paying more, maybe you are buying more expensive types of food. I’m not seeing much inflation, and I lived through the 1970s so I recall what high inflation was like.
Andy, I complete agree. I was just making the point that if we use them, it proves my point that money has been really tight since June 2008. But yes, they mostly reflect micro factors, or international macro factors.
I probably need to do an update, as I think people took my comment too seriously. I don’t think we can use them to fine tune the economy, my only point was that if we were going to use them, it supports the tight money view. I see them as just one of many indicators, and I find TIPS spreads much more reliable.
David, You said;
“How can crashing commodity prices signal the Fed is too tight, but spiking commodity prices not signal the Fed is too loose?”
That’s the question I’d like the conservatives to answer. It’s easy for me to tell a story; commodity prices are still far below 2008 levels, hence we need easier money. But as I said above, I consider commodity prices just one of many indicators, and far from the best.
But again, how would Ryan answer your question, or the other conservatives who think commodity prices are the correct measure of inflation?
Rod, You were far ahead of most, but NGDP growth expectations kept falling from October 2008 to March 2009. So you were wrong in arguing money was easing during that period. Money was getting tighter, as there is no lag between monetary policy and long term NGDP growth expectations.
19. December 2010 at 10:11
Everyone, I left an update at the end to reflect the comments, and correct a mistaken impression left by the wording of my post.
19. December 2010 at 10:31
Scott, you wrote: Rod, You were far ahead of most, but NGDP growth expectations kept falling from October 2008 to March 2009. So you were wrong in arguing money was easing during that period. Money was getting tighter, as there is no lag between monetary policy and long term NGDP growth expectations.
Hmmm, I was wrong, was I? Funny how the economy turned up almost exactly when I said it would and that I made that forecast entirely on what I’ve learned about tight and easy money over the last 35 years.
Maybe my model is right and your model is wrong? It’s at least a possibility isn’t it? I would love to see a proof of the statement “there is no lag between monetary policy and long term NGDP growth expectations,” especially given the results of that CNN poll I cited where they didn’t even offer the option of the possibility that the economy was turning up in the second quarter of 2009 (as it did.)
One thing I’ve learned from watching markets and the economy for over 30 years, Scott, is that expectations are almost always wrong at turns, up or down. In fact, the turn is usually well underway before expectations swing the other way.
Proof’s in the pudding, Scott. The market turned when easy money said it would turn. What was your forecast in Dec 2008, or even in March 2009, or possibly even in June 2009. After all, real GDP did turn up in the second quarter of 2009.
I mean, really, what’s it take to get some serious consideration for an idea that clearly works in here?
19. December 2010 at 12:33
I’m still not a Democrat, but at this point I’d take every corrupt Democrat over every honest Republican. The number of the latter is around 2, and they want to wreck the country in an honest way.
I think Krugman’s exactly right about Ryan.
19. December 2010 at 15:14
Commodity prices respond to global demand and monetary policies. Indian and China are buying a lot of gold, and have inflation.
Oil is set on the NYMEX, is highly speculative, and perhaps manipulated. You have sovereign wealth funds trading thru cloaked identities.
Oh, I am sure Putin would not buy and sell digital barrels of oil to drive prices higher. Right now, about 20 digital barrels trade for every real barrel.
I am a small business guy. I am not some Democrat.
But I am utterly mystified by the grip that the mantra “tight money and gold” has on my conservative friends. It is a type of religion. They are feverishly seeking out any examples of inflation, no matter how poorly grounded. Constantly predicting runaway inflation. (Yet, when Reagan was President, the right-wing honked for looser monetary policy, so there is something funny going on here).
Fittingly, conservative radiocasters are bombasting about gold all the time, raising the fever. Indeed, gold may have a run yet, if Indian and Chinese keep buying. That is where the price is set, not in the USA.
Few point out that adjusted for inflation, gold is still down from 1980s peaks. If you bought gold then, you are still a loser, and a loser who collected no interest along the way.
This is another terrific post by Sumner.
19. December 2010 at 17:58
Great post.
Good luck Mark! At least you have a strategy, unlike my spaghetti (throw everything you got and see what sticks) approach!
19. December 2010 at 18:57
Mike Sandifer,
I quite relate to your sentiments about the Republicans vs the Democrats. I’ve never been a fan of either party, and both are crafting some of the worst public policy reasonably imaginable, but still, when it comes down to all of it, I’d rather vote Democrat than Republican for the same reasons as you. Maybe my coming of age in the Bush years plays a role in this — I think some political scientists did a study suggesting that the president in office when a person turns 18 has significant impact on a person’s political leanings. I can imagine many reasonable people a decade or two older than me leaning Republican, even ceteris paribus.
Shane,
I’m just a lowly 4th year undergrad at Dartmouth, but if you’re looking for a job with the econ department here, I know some of the professors well enough to perhaps do some email introductions. You can email me at johnleemk AT gmail DOT com if you’d like to chat about Dartmouth, etc.
20. December 2010 at 18:15
Rod, You said:
“Hmmm, I was wrong, was I? Funny how the economy turned up almost exactly when I said it would and that I made that forecast entirely on what I’ve learned about tight and easy money over the last 35 years.
Maybe my model is right and your model is wrong? It’s at least a possibility isn’t it? I would love to see a proof of the statement “there is no lag between monetary policy and long term NGDP growth expectations,” especially given the results of that CNN poll I cited where they didn’t even offer the option of the possibility that the economy was turning up in the second quarter of 2009 (as it did.)”
Money became slightly less contractionary after March of 2009, with QE1. That’s when asset prices turned up. The economy generally turns up a few months after the asset markets, and that’s what happened.
I think my approach has done fine. I said money was way too tight in late 2008, and was right. I said QE1 would help just a little, but not produce a robust recovery, and I was right. I said the Greek crisis would hurt the US more than Germany and I was right. I said QE2 rumors would help the asset markets, and I was right. I said it would also help the economy, and so far I seem to be right. I said the initial fiscal stimulus wouldn’t do much, and I was right.
No disrespect, but it’s not hard being right. If monetary policy affected NGDP growth expectations with a lag, then there would be $100 bills lying on the sidewalk, and I believe in the EMH so I don’t think that’s likely.
BTW, didn’t RGDP fall in the 2nd quarter of 2009?
Mike, On money I agree with Krugman, on fiscal policy I am much closer to Ryan.
Thanks Benjamin.
21. December 2010 at 07:52
Some skeptics about QE2 (notably me) were encouraging the Fed to ease in 2008. I wrote “The Fed Does Right” NY Post 2-1-08 and “Don’t Blame Bernanke” Forbes.com 9-5-08.
But we are no longer talking about easing to accommodate a surge in the demand for bank reserves and currency in 2008. We are talking about easing to fine-tune the real economy in the first half of 2011 based on a gloomy misreading of cyclical indicators in the summer or fall of 2010.
When the Fed explicitly says it is now trying to “maximize employment” that’s time to worry — and time to short long Treasury bonds. As I recently explained in the Wall Street Journal, Ben Quixote is pursuing an impossible dream. And a risky one.
Remember Reynolds’s Second Law: “Inflation is always lower before it moves higher.”
21. December 2010 at 19:21
Alan, I’m a market efficiency guy, and I’ve been arguing inflation is not the problem since September 2008. So far I’ve been right, and the TIPS spreads suggest I’ll keep on being right.
I agree with you that it’s a terrible idea for the Fed to pay any attention to RGDP. I want them to target NGDP. We had roughly 5% NGDP growth for 2 decades during the Great Moderation. The the Fed allowed NGDP to fall in 2009 at the fastest rate since 1938. Even in the “recovery” NGDP is growing at less then the 5% trend. It grew at 11% annual rate during the first 6 quarters of the low inflation Volcker recovery (1983-84). That’s way more then we need now, but at the time the WSJ said money was too tight. How things change.
22. December 2010 at 09:21
Scott, we are always right until we are wrong, usually just after hubris has set in. I can’t believe how blase you are about the lethal cocktail of monetary and fiscal easing combined.
Less than expected inflation in the US seems mostly due to the emerging markets willingness to inflate their own economies rather than appreciate and see the inflation in the US.
23. December 2010 at 21:46
@Benjamin Cole:
Point of trivia:
Oil is no longer set on NYMEX, hasn’t been for over a year. The WTI started diverging from the Brent in 2009 so the Saudis switched to the Argus Sour Crude Index which has futures traded on the CME not the NYMEX. The WTI is still traded on the NYMEX but isn’t nearly as important as it used to be.
I also agree that gold is NOT a good investment. It is a currency hedge and should be treated as one. Treating a commodity with the supply/demand curves that gold has as an investment is a very bad idea.
@James in London:
“Less than expected inflation in the US seems mostly due to the emerging markets willingness to inflate their own economies rather than appreciate and see the inflation in the US.”
That is an interesting point.
24. December 2010 at 03:02
[…] at TheMoneyIllusion, Scott Sumner takes a shot at what he refers to as “Disinflation Denial.” His point is that prior to the recent run-up, “commodity price indices fell by more […]
24. December 2010 at 17:43
James, I am opposed to the fiscal easing, and we don’t have any significant monetary easing. If we did have adequate monetary easing, we would not have done the fiscal easing, which I agree is worrisome, and could lead to inflation in the long run. Monetary easing would make the budget deficit smaller, and hence reduce the pressure for future monetizing the debt.
How does inflation overseas reduce inflation here?
24. December 2010 at 22:03
Prof. Sumner,
Wouldn’t accumulations of the American money stock (sovereign wealth funds) delay inflation in the US?
25. December 2010 at 17:15
“I am opposed to the fiscal easing, and we don’t have any significant monetary easing”
Who do you think monetizes the $1.3 trillion annual deficits? Who buys the Treasury debt? The banks. Where do they get the money? And how can the system absorb that much fiscal stimulus without interest rates rising?
The Fed via monetary policy funds the Fiscal deficit.
SurviveTheGreatInflation.com.
26. December 2010 at 21:19
W. Peden, Probably not, as they don’t actually accumulate US dollars, they buy dollar assets like bonds. However I suppose if they accumulated a lot of debt it could keep interest rates near zero, and thus keep us in a liqudity trap. So perhaps you are right.
Michael, I understand your point, but it seems to me that interest on reserves changes the game. If they were monetizing the debt with non-interest bearing currency (which is what the term meant in the old days) then I’d agree with you. But I just don’t see the inflation, and neither do the markets.
29. December 2010 at 03:51
[…] U.S. monetary policy is only one of them and probably is not the most important. P.S. See Scott Sumner for more on what commodity prices tell us about monetary […]
15. January 2011 at 07:50
The problem with using commodity prices, now or as in 2008, is that in the past commodity prices went as the US economy went, whereas today, commodity prices follow the world economy. The US economy has been anemic since 2006, regardless of GDP numbers, while commodity prices have retraced much of their losses. So monetary policy makers lose control if they use commodity prices as a primary indicator. I have said this many times over the last three years: high commodity prices are effectively a TAX in the US because they dampen demand, as opposed to the 1970s when they were driven by demand. Simply, US income growth is not strong and is not distributed equally with low saving consumers who ordinarily are heavy buyers of resource intensive goods such as consumer durables. High income consumers tend to save more, and spend less on consumer durables. This disparity adds to the dampening pressure of high commodities prices on consumer demand.
JR
15. January 2011 at 15:03
Jolly, That sounds about right. The solution is more AD.