I beg you all to stop talking about German inflation
Everyone who reads blogs knows that a person’s IQ immediately drops by 15 points as soon as they start talking about politics. (Make that 20 if the post contains the word “lie.”) Something similar occurs with Germany and inflation. Here are the facts:
1. The German inflation rate should have no bearing on ECB policy, just as the Wisconsin inflation rate has no bearing on Fed policy.
2. If the German inflation rate were relevant to ECB policy, then the ECB policy should be more expansionary because German inflation is below target.
3. Germans are not inflation-phobic because of the 1920-23 hyperinflation; almost no one alive today remembers the hyperinflation. On the other hand a few very old Germans do recall how the deflation of 1929-33 put Hitler in power. The Swiss people (who are mostly ethnic Germans) did not have a hyperinflation and are equally inflation-phobic. It’s an ethnic German thing, not a 1920 memory.
There’s no longer a deutschmark, and thus German inflation doesn’t matter. If inflation mattered at all (it doesn’t, only NGDP growth matters), then the inflation rate that mattered would be the eurozone inflation rate. The mere fact that the press discusses German inflation might lead some Germans to believe there is an issue there, that they have some sort of debatable point to make. Not so, the German views on inflation are completely insane, with no shred of rationality, no redeeming logic at all. So let’s stop talking about the subject as if there’s a valid issue at stake. When uncle Fred claims he’s Napoleon Bonaparte, you discuss whether to put him in an asylum, not whether he used the right strategy at Waterloo. So stop talking about German inflation.
On the other hand the Germans are completely right about their fiscal policy and CA surplus, and the rest of the world is crazy.
PS. Tyler Cowen has a new post that criticizes the Summers-Krugman argument on negative real interest rates:
I cannot, however, agree with the central arguments about negative real interest rates, and the necessity for negative natural rates of interest (there are a variety of interlocking claims here, so do read them for yourself. I am not sure any brief summary can quite reproduce the arguments, which are also not fully clear).
Because Tyler also linked to my recent post in the opening paragraph, some readers might assume we differed on real interest rates. We don’t–I agree that negative real interest rates on Treasury securities are not the issue. The Keynesians have it all wrong.
Tyler also suggests that the Summers-Krugman thesis supports his views on the Great Stagnation. I think there is some truth to that. I’ve certainly been supportive of the stagnation thesis. But I’d add that there is a big difference been stagnating productivity and high unemployment. I have argued that the current high unemployment rate reflects both demand deficiency and adverse shifts in AS due to things like extended unemployment compensation. As demand gradually recovers and unemployment compensation is cut back to a maximum of 26 weeks I expect unemployment to continue falling back to the natural rate.
I strongly disagree with this.
The velocity effect on currency balances, from inflation, just isn’t that strong. At persistent negative rates of return we are much more likely to see an interdependence of AS and AD and some kind of cascading collapse of both. Or maybe it is simply better to say the framework has broken down than to try to squeeze one’s own predictions out of that set up.
Zimbabwe shows that it’s dangerous to mix real and nominal factors when modeling GDP. (Or America in the 1970s if you want a more pertinent example.) The stagnation story is about real interest rates. Nominal rates can be as high as the Fed wants, and velocity is highly sensitive to changes in nominal rates. To summarize:
X factors -> RGDP stagnation -> low real interest rates
Tight money -> slow NGDP growth -> high unemployment and low nominal i-rates
Don’t mix them up.
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18. November 2013 at 07:01
Scott,
FANTASTIC job on Kudlow on Saturday! I think that was the clearest the Market Monetarist views have been expressed on his show yet (including your past visits).
-Mark
18. November 2013 at 07:23
Thanks Mark.
18. November 2013 at 07:56
Are we talking about that Kudlow where it was Scott and Schiff in there? Or is there another one I am not aware of?
PS: And this is a good post. This whole debate about an era of negative real rate of interest seems very uninformed to me exactly for reasons that you said – mixing up supply and demand side.
And in a way it is also rather frustrating. Or am I the only one who finds it strange that in a debate where we talk about inflation, real interest rates and nominal interest rates noone besides Scott even mentions nominal income AKA NGDP? Like for instance why it was relatively OK for many countries to experience deflation during second half of 19th century? Could it be because of high real interest rates?
18. November 2013 at 08:37
What is linkage between them:
(1) “X factors -> RGDP stagnation -> low real interest rates”
and
(2) “Tight money -> slow NGDP growth -> high unemployment and low nominal i-rates”
I guess I had always interpreted this stuff as either:
(1)->(2) …. and or ….. (2)->(1)->(2), which equates ‘tight money / contractionary monetary policy’ to ‘X factor’
And as a result, loosening monetary policy could be a positive X factor that boosts RGDP in the short run. Rinse and Repeat.
The thought that maybe this isn’t on target is a bit of a bummer.
18. November 2013 at 08:38
The reason German inflation is important (at least in theory) is thus. The basic EZ problem is the disparity in competitiveness between periphery and core (aka Germany). The EZ is currently trying to get competitiveness to converge by imposing deflation (in both senses of the word) on the periphery (a pretty disastrous way of doing it, but that’s common currencies for you).
Thus inflation in the periphery below 2% is NOT A GOOD REASON to EZ wide stimulus. In contrast, below 2% inflation in Germany probably IS A REASON for EZ wide stimulus – assuming that doesn’t greatly increase inflation in the periphery.
At least that’s the theory. Unfortunately from the figures I’ve seen, it’s doubtful that the severe cut in demand in the periphery has actually caused any significant amelioration of price increases there.
I.e. the whole Euro project looks like a disaster to me.
18. November 2013 at 11:28
How much of ‘X factors’ is “worldwide demographic trends”?
18. November 2013 at 13:45
Thanks JV, For an example of what happens when you ignore NGDP, check out my new post.
Dustin, Which linkage confuses you?
Ralph, You said;
“The basic EZ problem is the disparity in competitiveness between periphery and core (aka Germany).”
I agree the euro is a disaster, but the conventional explanation is actually wrong. Money is too tight everywhere, according to the ECB’s own target. Even in Germany. And their target should be NGDP growth. With sound monetary policy the regional divergences would be very manageable.
Brian, Part of it, I’m not sure how much.
18. November 2013 at 14:57
http://tunein.com/radio/The-Larry-Kudlow-Show-p67495/
Scott’s segment begins around 1h 30m
18. November 2013 at 14:57
Well, I have really thought of it as:
X Factor (negative shock) -> tight money -> slow NGDP growth *and* RGDP stagnation … to which the solution is loose money policy to offset the X Factor and revive NGDP and RGDP growth.
But as I think more through it, I’m wondering if I’ve simply made that up. Are you asserting those 2 causal chains run in parallel (where each step of each chain is roughly equal)? Or in a single series?
Drawing from your paper ‘Defense of NGDP Targeting’ “a spike in nominal GDP can push real GDP up, though not for long”. So while there is linkage between the NGDP and RGDP, I am trying to clearly see it without confusing the 2 causal chains.
18. November 2013 at 15:04
Sorry, Scott actually starts in the segment before 1h 30m
18. November 2013 at 15:37
Dustin,
My interpretation is that the top causal chain is a long run AS secular stagnation story. The bottom causal chain is a short run AD business cycle story.
P.S. I thought you made some good points vis a vis L. Randall Wray at NEP.
18. November 2013 at 16:52
Mark A. Sadowski,
Ok, I’ll consider them along those lines and see where I end up.
Re: L Randall, thank you.
18. November 2013 at 19:47
“Germans are not inflation-phobic because of the 1920-23 hyperinflation; almost no one alive today remembers the hyperinflation. On the other hand a few very old Germans do recall how the deflation of 1929-33 put Hitler in power.”
Deflation is necessary after a hyperinflation, if the government is to retain control over the money.
Actually, Germans are indeed inflation-phobic because of Weimar. Deflation didn’t put Hitler in power. Hyperinflation did it. He gained popularity and power during the 1920s.
There are many reasons why Hitler came to power. The German philosophical movement of the 19th century was required. The Treaty of Versailles, which imposed massive reparations on the German people was required. Nationalistic furver was required.
If deflation is claimed as responsible, then the actual blame must be on that which made the deflation necessary, which of course was the previous hyperinflation. Thus hyperinflation was a component of what put Hitler in power.
18. November 2013 at 19:47
“If inflation mattered at all (it doesn’t, only NGDP growth matters), then the inflation rate that mattered would be the eurozone inflation rate.”
NGDP doesn’t matter. Unhampered economic calculation is what matters.
18. November 2013 at 19:48
“Not so, the German views on inflation are completely insane, with no shred of rationality, no redeeming logic at all.”
No, YOUR views on inflation are insane, devoid of logic, and completely wrong.
19. November 2013 at 09:32
Dustin, See Mark’s comment. They run in parallel.
19. November 2013 at 12:21
when you look at inflation rates in europe,
then the core is tightly integrated, see the very interesting, overall important
http://epp.eurostat.ec.europa.eu/portal/page/portal/macroeconomic_imbalance_procedure/indicators
the 11 commandments.
and France tightly tracking Germany, or vice versa, stock market EWG vs EWQ as well.
Therefore german inflation is THE proxy for the central figure of the world, Euro inflation, the <= 2.0% target the Fed and BoJ have subscribed to last year as well.
It is THE LAW.
You shall not have any other gods besides the Bundesverfassungsgericht and the Bundesbank. Amen. : – )