Inflation created by the Fed boosts living standards (temporarily)

Lots of conservatives have been arguing that Americans are being hurt by rising prices, and that the Fed is contributing to higher prices.  Both statements are true, but the part of inflation caused by the Fed is actually boosting living standards.  Unfortunately, recent inflation has been supply-side.

The Fed creates inflation by shifting the AD curve to the right.  That boosts prices and real output, and means that Americans have more real income.  More people work, those with jobs work longer hours, and income from capital also rises.  In contrast, supply shocks reduce living standards.  Here’s where things get confusing.  Higher oil prices are generally viewed as a supply shock, and yet many believe the Fed has helped push oil prices higher.  Consider the following three cases:

1.  Fed stimulus causes US RGDP to increase, and this boosts oil demand and real oil prices.

2.  The LDCs boom, which means higher oil prices and more exports for the US.

3.  Turmoil in Libya leads to a reduction in world oil supply.

The first case is unambiguously good–US consumers have higher living standards.  Remember how much better off we were in the spring of 2008 when oil was $140, compared to the spring of 2009 when it was only $40?

The second case is both good and bad–ambiguous.

The third case is unambiguously bad, but has nothing to do with the Fed.

To summarize.  The upswing in inflation has hurt American consumers.  The Fed has contributed to that upswing.  The Fed’s actions helped American consumers.  Isn’t economics easy?

(No wonder we’re losing the debate.  Trying making that argument on a cable news station full of people shouting at each other.)



8 Responses to “Inflation created by the Fed boosts living standards (temporarily)”

  1. Gravatar of marcus nunes marcus nunes
    6. July 2011 at 10:54

    The Fed´s action doubly hurt US consumers back in 2008 when it let NGDP nose dive to offset commodity/oil prices. That just wouldn´t have happened if NGDP kept growing along the target level. At present, since NGDP is far below any reasonable target level higher commodity/oil prices cause a triple dose of pain. The Fed is still tied to IT so in effect it is still trying to offset higher C/O prices at a much lower level of output employment and wages.

  2. Gravatar of dirk dirk
    6. July 2011 at 11:02

    Speaking of cable news stations, why do you think Larry Kudlow keeps arguing that monetary stimulus has created oil and food inflation? Does he subscribe to a different economic theory, or do you think he is merely saying what he thinks his old, conservative audience wants to hear?

  3. Gravatar of Morgan Warstler Morgan Warstler
    6. July 2011 at 11:32

    Scott, you aren’t really getting to the point / idea held by conservatives…

    RGDP can’t really grow in the face of:

    1. immediate global demand shocks in oil prices every time, the burners get cooking.

    2. government in the way.

    As such, conservatives would PREFER to solve for #2 FIRST.

    Take your early thinking that the GD led to big Dem wins, and flip it over… this whole crisis will continue to lead to big GOP wins.

    Big GOP wins solve for #2, then we can have a fruitful approach to monetary without suffering as badly for #1.

    Once again, Scott Sumner’s ideas are far more compelling when couched aggressive Uncle Milty-style “government is bad!” rhetoric.

    When DeKrugman hates you so much that they lie about your Monetary theory – you will be on the right track.

  4. Gravatar of Scott Sumner Scott Sumner
    7. July 2011 at 07:53

    Marcus, I agree. They claim to look at core inflation, but focus too much on headline inflation.

    Dirk, Kudlow has a market-oriented view of macro–which is good. But he should look at TIPS spreads, not commodity prices.

    Morgan, You said;

    “Once again, Scott Sumner’s ideas are far more compelling when couched aggressive Uncle Milty-style “government is bad!” rhetoric.”

    See my new Gordon Brown post.

  5. Gravatar of D. Watson D. Watson
    7. July 2011 at 08:38

    I’ll take issue with your definition of ‘good.’ This is solely good for particular segments of America. Growth in LDCs means less world poverty, hunger, and other bad things. Increases in oil prices lead to increases in food prices, particularly while US and EU food policy connect the two, harming LDCs doubly despite US growth. I’ll give in that if you’re talking to most conservatives, they’re thinking about those particular segments of the US first and so that’s the policy argument to be made to convince them, so I wouldn’t ask to call the first ambiguously good. But I still worry about calling growth in LDCs only ambiguously good.

    We’re all still economists. Growth = 🙂 is part of our DNA.

  6. Gravatar of D. Watson D. Watson
    7. July 2011 at 08:38

    That didn’t work quite. Growth = good is part of our DNA.

  7. Gravatar of Scott Sumner Scott Sumner
    8. July 2011 at 17:29

    D. Watson, If you are worried about the poor, recall that 99% of the poor live in LDCs. So growth in LDCs is most certainly good for the poor.
    Growth in LDCs also boosts exports, which reduces unemployment in the US.

    The insane ethanol program liinks food and energy prices. I think we both agree that should be abolished.

  8. Gravatar of jocuri zane jocuri zane
    6. August 2011 at 10:54

    jocuri zane…

    TheMoneyIllusion » Inflation created by the Fed boosts living standards (temporarily)…

Leave a Reply