Lowflation? LOL. Try again!
The economics profession made a serious mistake a few decades ago when they latched onto “inflation” as a key macroeconomic indicator. People were very upset about inflation during the Great Inflation of 1966-81, for reasons totally unrelated to the reasons macroeconomists think inflation is important. Since everyone was talking about inflation, macroeconomists wanted to put it into their models. Nobody was talking about nominal GDP.
[As an analogy, macroeconomists put short-term interest rates in their monetary models because central banks usually target that variable. In the 1930s George Warren was mocked for saying that the price of gold is “the” indicator of monetary policy. But how’s that different from new Keynesians? After all, when Warren was alive central banks did target the price of gold.]
In any case, it’s become increasing clear that inflation is not the right variable–it does not describe the nominal shocks hitting economies. And Europeans in particular are paying a heavy price for this mistake, as when the ECB sharply tightened monetary policy in 2011 because a completely meaningless headline inflation number (including “austerity” VAT increases and imported oil) had briefly risen above their 2% target.
As inflation becomes more and more discredited, pundits try ever more clever techniques to make it seem relevant again. Here’s a recent article from The Economist:
Against this background, it is unsurprising that inflation is stuck at just 0.5%. Although the European Central Bank (ECB) took steps to counter “lowflation” in early June, the worry is that it has still not done enough. In a survey of the euro-zone economy published on July 14th the IMF urged the ECB to adopt quantitative easing””creating money to buy assets including sovereign bonds””if inflation remains too low.
Lowflation represents a particular threat to highly indebted countries like Portugal.
It’s amazing the lengths to which pundits will go to NOT mention nominal GDP.
Let’s compare Portugal and Switzerland. Over the past 6 years both have seen inflation fall from the low single digits, to near zero. But look at the nominal GDP numbers (World Bank) for the two countries:
Year Portugal Switzerland
2007 169.3 540.8
2008 172.0 567.9
2009 168.5 554.3
2010 172.9 572.1
2011 171.1 585.1
2012 165.1 591.9
2013 165.7 603.2
Portugal’s NGDP is down over 2%, while Switzerland’s is up over 11%. Not surprisingly, although both countries suffer from “lowflation,” Switzerland has seen RGDP grow 8% over this period, while Portugal’s RGDP has fallen by 7%.
And NGDP isn’t just the right metric for nominal shocks and the business cycle, it’s also the right variable for the debt crisis. Nominal income is the resource that individuals, business, banks and governments have to repay nominal debt. Why in the world would someone talking about a debt crisis mention “inflation?” What does that have to do with debt? What if a country has 0% inflation and 10% RGDP growth?
That’s not to say inflation is never correlated with demand shocks–most of the time it is. But NGDP is 100% correlated with demand shocks. So if you are worried about nominal shocks hitting the economy, why not use an accurate nominal shock measure like NGDP? Why use a metric that is correlated with NGDP when the economy is hit by demand shocks, but not supply shocks?
Of course even NGDP isn’t going to explain all the movements in RGDP (but it will do better than inflation.) Switzerland has better supply-side fundamentals, so even if the ECB had done enough monetary stimulus to cause Portugal’s NGDP to rise by the same 11% as in Switzerland, their RGDP performance might well have lagged Switzerland. Nonetheless, Portugal would have done somewhat better in terms of growth, and their debt crisis would have definitely been much milder.
You want to see “lowflation?” China’s inflation rate (GDP deflator) averaged 0.75%/year between 1996 and 2003—pretty close to Japan. Now check out the NGDP numbers for the two countries.
I’m begging the economics community. Stop talking about inflation when you really mean nominal income. And stop coining terms like ‘lowflation’ in a pathetic attempt to add epicycles to the obsolete inflation-oriented models of macroeconomics.
Inflation, interest rates, income inequality—the “i-words” don’t matter. NGDP, nominal wages, consumption are what matter. BTW, the current account deficit also doesn’t matter, as I point out in my newest Econlog post.
Tags:
2. August 2014 at 07:32
“Predictions:
Social Security will go on and on.
The US will keep running budget deficits for decade after decade.
Australia and the US will keep running current account deficits.
Germany will keep running CA surpluses, as will East Asia.
The NYC/LA/SanFran/London/Dubai/Shanghai/HongKong/Singapore/Sydney housing bubbles will never burst. There will be times when they appear to burst, but it will be an illusion. Prices will bounce back.
Peak oil will keep getting delayed.
NGDP will keep going up and up.”
http://econlog.econlib.org/archives/2014/08/if_something_ca.html
Love it!!!!
2. August 2014 at 07:54
Prof Sumner,
I’m interested in your NGDP targeting ideas and was hoping you could point me in the direction where you address the following:
1) Data revisions and how they would impact implementation of NGDP targeting (e.g.: 2014Q1).
2) Suppose the Fed ensures that nominal gdp growth is 3%. Aren’t we interested in distinguishing a case in which real gdp growth is -7% and the inflation rate is 10%, and the one in which real gdp growth is 6% and the inflation rate is 2%?
2. August 2014 at 08:45
“Stop talking about inflation when you really mean nominal income.”
In the same spirit, they should stop talking about inflation when they really mean cost of living.
2. August 2014 at 10:00
Well said.
Insofar as price indexes should have a role in economics, they’re as a measure of costs (as Michael Byrnes says) and as a measure of AS policy success/failure in an NGDP targeting world.
In the UK, we need to stop talking about “the cost of living” where we mean “the standard of living” or worse “real wages”.
2. August 2014 at 10:00
(Or more realistically, an NGDP targeting country.)
2. August 2014 at 11:25
Reported RGDP goes up when NGDP goes up even if there is no increase in real production.
2. August 2014 at 11:45
Excellent blogging.
The perverted obsession with nominal price indices—how did this happen? Richard Fisher actually believes a subjective nominal price index should be at 100 through the decades…
Surely robust real growth results in spasmodic bottlenecks, resolved by the price signal that compels new supply…real estate too goes up…the price of prosperity is mild inflation as measured….
The explanation of the current fixation on nominal price stability is beyond economics, it is into the ken of psychiatrists and sociologists…
2. August 2014 at 12:05
Excellent blogging.
The perverted obsession with nominal income indices””how did this happen? Benjamin Cole actually believes a subjective nominal income index should be at 5% growth through the decades…
Surely robust real growth results in spasmodic bottlenecks, resolved by the price signal that compels new supply…real estate too goes up…the price of prosperity is mild income volatility as measured…
The explanation of the current fixation on nominal income stability is beyond economics, it is into the ken of psychiatrists and sociologists…
2. August 2014 at 13:50
Wawawa, I’ve discussed data revisions in older posts, you can try searching. Remember, we are targeting NGDP one or two years ahead, so near term revisions are less important.
2. No, the monetary authority shouldn’t care at all about the P/Y split, but other policymakers might care. If Y is too low you need supply-side reforms, not more money.
2. August 2014 at 14:23
Peter Schiff desperately attempts to defend his poor investment advice in the comments section of this new column:
http://www.bloombergview.com/articles/2014-07-30/when-entertainment-passes-for-investment-advice
2. August 2014 at 17:23
NGDP changes are economic shocks when inflation is low, otherwise there is more to it:
http://informationtransfereconomics.blogspot.com/2014/08/lowflation-is-meaningful-concept.html
@benjamin cole, you said: “The perverted obsession with nominal price indices””how did this happen?”
I think it might be the other way around. Economic models have failed to capture the phenomenology of inflation and subsequently some economists began to say it was a meaningless concept. Saying the obsession is “perverted” may just be sour grapes. There is an all-too-common tendency to throw stuff that isn’t understood out of the discussion.
2. August 2014 at 22:14
Scott Sumner
Do you think that if the leadership of monetary authority was directly elected by public expectations of growth would be generated because people would elect bank managers who they expect to generate growth? I hope that makes sense.
2. August 2014 at 23:27
Scott Sumner
Could it be the fed is pursuing too low a target for inflation becuase they may be worried about risks from QE or large expansion of balance sheet? Im not saying their concerns are valid but do you think this may be why the fed is pursuing to low a target for inflation?
2. August 2014 at 23:31
Jason Smith—Well, I got tired of calling a monomania with price stability a “peevish fixation,” so I went with “perverted obsession.”
I am not sure I follow your comment. I think a zealous and extreme adherence to rigid price stability (as dubiously measured) is a demented dogma, not monetary policy. What don’t I understand?
3. August 2014 at 05:05
This is a good MM sentence, I’d put it right at the top of all of your MM explainers. And then keep repeating it.
“Nominal income is the resource that individuals, business, banks and governments have to repay nominal debt.”
The first thought it raises in mind of conservative who has grokked NGDPLT is:
Well if NGDP is lower doesn’t that limit how much debt people take on?
So think about that answer.
—–
I had another idea last night about how to get conservatives to accept NGDPLT:
What if Congress instructed the Fed to adopt 6% NGDPLT.
(Morgan your LT is SO BIG!!!)
But, the law also came a refundable income tax credit equal to the inflation component of NGDP?
So in 2014 we are only getting 2% RGDP, and the machine is making us hit 6% with 4% inflation.
But everybody gets to keep 4% of their income to pay for the inflation. A rebate check, where the government fiscal policy is apologizing for not getting all 6% of the NDGP in Real Growth.
Remember that once the Fed goes on auto-pilot with NGDPLT, fiscal policy (government) becomes 100% responsible for inflation.
It seems like what this would do is embed tax-cut Keynesian stimulus into downturns, anytime the government saw inflation, we’d know it was going to receive less money to spend, but citizens would be keeping more money..
I’m sure there’s a flaw here somewhere, but it seems like a policy conservative would listen to from MM.
3. August 2014 at 09:46
@benjamin cole: I’m sorry, I misunderstood your comment. I misread it as critical of the concept of inflation in economics, rather than as critical of central banks’ focus on it to the exclusion of all else (which does seem misguided).
3. August 2014 at 09:48
What am I to make of this?
“Goldman Warns Of 6.5% Japanese GDP Collapse, Worst Since Lehman”
http://www.zerohedge.com/news/2014-08-02/goldman-warns-65-japanese-gdp-collapse-worst-lehman
3. August 2014 at 11:33
It’s ZeroHedge. Good for entertainment and nothing more.
3. August 2014 at 11:43
CMA, I can’t answer either question. I don’t know.
Travis, That’s expected, there was a 3% sales tax increase on April 1.
5. August 2014 at 04:29
Portugal vs Switzerland comparison:
Not unrelated to NGDP movement, the population of Portugal has stayed flat at 10.4m over the last 10 years, while Switzerland has risen from 7.4m to 8.1m.
Not unrelated to NGDP movement, the employed population in Portugal has falled from 5.2m to 4.7m and in Switzerland risen from 4.4m to 4.9m. Net migration has driven all and more of the rise in the Swiss population, working and non-working.
So 5.2m played 4.4m, now 4.7m plays 4.9m – one helluva swing.
5. August 2014 at 05:05
James, Interesting data. One of the underreported stories is the way that demand shocks lead to population flows between countries.