Will people please stop talking about inflation?

We have a debate about whether we need more or less inflation.  On one side are people like Paul Krugman, calling for more inflation.  Many conservatives complain that inflation is too high.  But neither are actually talking about inflation, and hence they are talking right past each other.

Conservatives constantly moan about how Americans are seeing their living standards fall as food and energy prices soar.  OK, but then the real problem isn’t inflation, its falling RGDP due to less oil and less food.  It’s a supply shock.  This would be reducing living standards whether inflation was 0%, 10%, or 100%.  It reduces living standards by causing prices to rise faster than nominal incomes.  So call it what it is—falling real output.  This does raise the relative price of food and energy.  But inflation isn’t a relative price change; it’s a rise in the overall price level.  Whether the increase in the relative price of food and energy leads to an absolute increase in the price level depends entirely on what the Fed does.  But either way, Americans will suffer a decline in living standards.

On the other side you have progressives calling for a higher inflation target.  But they don’t really want more inflation; they want more AD, more NGDP growth.  How do I know this?  Because if you told them that NGDP was set to rise 8% next year, and asked them whether they’d rather the increase be 6% real growth and 2% inflation, or vice versa, it’s pretty obvious they take the real growth.  So they are actually calling for more nominal income, not more inflation.

Keynesians argue that we need inflation to lower real interest rates, and that this is the transmission mechanism for growth.  But this is wrong.  What matters is the nominal interest rate relative to NGDP growth, not relative to inflation.  If we get more NGDP growth, then at our current zero nominal interest rate we will be closer to the Wicksellain equilibrium natural rate, even if 100% of the NGDP increase is extra real growth. 

It pains me to see people talking past each other.  Here’s what I hear:

Conservatives:  “Americans are suffering from falling RGDP.”

Progressives:  “No, we need more AD, more NGDP.”

Me:  Huh?


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15 Responses to “Will people please stop talking about inflation?”

  1. Gravatar of John hall John hall
    6. July 2011 at 11:07

    Scott,
    I’m not really sure I understand what you mean by this:

    “What matters is the nominal interest rate relative to NGDP growth, not relative to inflation. If we get more NGDP growth, then at our current zero nominal interest rate we will be closer to the Wicksellain equilibrium natural rate, even if 100% of the NGDP increase is extra real growth.”

    If we have 0% nominal rates and expected nominal GDP growth goes from below target to on target, I can see why you would say that we have become closer to the natural rate.

    If the progressives are just arguing that one mechanism by which this could occur is to increase expected inflation and lower real interest rates in order to stimulate real growth, then wouldn’t it still be within your framework. Are you arguing that you don’t think this mechanism works? Or are you just saying that you would prefer a different mechanism to get the final result of the on target expected NGDP growth?

  2. Gravatar of Morgan Warstler Morgan Warstler
    6. July 2011 at 11:45

    “Conservatives constantly moan about how Americans are seeing their living standards fall as food and energy prices soar. OK, but then the real problem isn’t inflation, its falling RGDP due to less oil and less food. It’s a supply shock.”

    I think a supply shock is when there suddenly is a ton more or less than what is expected. We EXPECT commodity prices to shoot up when we print money.

    Investors putting money into commodities because they can’t find returns elsewhere isn’t a supply shock.

    Predicted global demand increases when the economy picks up a little bit isn’t a supply shock.

    This isn’t really about ethanol is it? I mean I guess you could say ethanol has really effected supply of food. And I guess you could blame Libya – but these aren’t really NEW “supply shocks” are they?

  3. Gravatar of Blunt Instrument Blunt Instrument
    6. July 2011 at 12:20

    the real problem isn’t inflation, its falling RGDP due to less oil and less food. It’s a supply shock.

    Yes, yes, and yes, again!!! We are not experiencing monetary inflation. This is not the 70’s writ large (well, not completely, anyway). Increasing prices do not necessarily equal a rise in inflation. Please shout this from the rooftops. Thank you, Scott.

    P.S. Welcome back. You were sorely missed.

  4. Gravatar of TravisA TravisA
    6. July 2011 at 12:55

    Scott, are you saying that lower real interest rates due to inflation are *never* the cause of growth or just isn’t *always* the cause of growth?

    I agree that if we had a positive supply shock that caused real GDP to increase, then the transmission mechanism for growth is not lower real interest rates. Also, if growth came because inflation had eroded the real wage and thus people were cheap enough to hire. Or perhaps machinery or inventory needs to be replenished, then growth can occur without the real interest rate decreasing. But it certainly seems possible that a lower real interest rate could in some situations cause growth.

  5. Gravatar of Lorenzo from Oz Lorenzo from Oz
    6. July 2011 at 20:36

    To put it even more simply, not getting the difference between prices and price level.

  6. Gravatar of Scott Sumner Scott Sumner
    7. July 2011 at 08:03

    John, Yes, inflation expectations are one way of looking at things, but NGDP is much better. Often they give the same reading, when they don’t NGDP will be more accurate. That was my point.

    Morgan, You said;

    “This isn’t really about ethanol is it? I mean I guess you could say ethanol has really effected supply of food. And I guess you could blame Libya – but these aren’t really NEW “supply shocks” are they?”

    Check out my next post–more demand from China means less supply to the US. That’s different from “printing money.” We printed money in 2008-09, and oil prices plunged. It’s not all about printing money.

    Thanks Blunt.

    Travis A, Never reason from a price change. Low interest rates don’t cause anything. But sometimes the thing that causes low interest rates (say more money) might cause growth. However, easy money usually raises interest rates over the medium term.

    Lorenzo, Yes, that’s something that confuses people, but it’s not the only point I’m making here.

  7. Gravatar of Justin Justin
    7. July 2011 at 11:25

    “On the other side you have progressives calling for a higher inflation target. But they don’t really want more inflation; they want more AD, more NGDP growth. How do I know this? Because if you told them that NGDP was set to rise 8% next year, and asked them whether they’d rather the increase be 6% real growth and 2% inflation, or vice versa, it’s pretty obvious they take the real growth. So they are actually calling for more nominal income, not more inflation.”

    I think many would welcome more inflation in addition to more real growth, as it would ease the real burden of debts and boost asset (home) prices.

  8. Gravatar of Alexander Hudson Alexander Hudson
    8. July 2011 at 08:25

    Ironically, I think the inflation from supply shocks is, if anything, a good thing. As you said, Scott, supply shocks are going to make us poorer no matter what. The question is how we become poorer. If we don’t allow inflation to rise in response to a supply shock, then we’re saying, “Okay, we’ll take our declining living standards in the form of increased unemployment.” At a time of 9+ percent unemployment and approximately 2 percent inflation, that’s a ridiculous tradeoff to make.

    In other words, inflation is one possible transmission mechanism by which the supply shock makes us poorer. We should welcome that means over the alternative.

  9. Gravatar of Scott Sumner Scott Sumner
    8. July 2011 at 17:31

    Justin, More real growth eases the burdens of debt just as much as more inflation.

    Alexander, I agree, it’s why I favor NGDP targeting.

  10. Gravatar of Ryan Ryan
    9. July 2011 at 05:29

    Prof. Sumner, what on Earth are you talking about?

    Inflation has always meant a general increase in the price level relative the money supply.

    You are re-defining the term to mean some sort of “comparatively higher growth rate in the price level of some goods relative to others.”

    That’s fine, but isn’t it disingenuous to suggest that no one is talking about inflation except you? You are clearly the one using the least common definition of the word “inflation.”

    Inflation is occurring, and your NGDP targeting theory is a pro-inflationary monetary policy. It makes little sense for you to redefine the basic terminology. If you favor increases in the money supply to drive additional demand, then it is what it is. That the inflation you endorse may potentially “kick start” a production spree to meet the additional demand does not alter the fact that your theory begins with inflationary monetary policy. That you parse these things into two sets of acronyms – RGDP and NGDP – to keep track of whether or not your inflationary policy actually does any good is irrelevant to the question of whether yours is an inflationary policy. It is. So why redefine inflation?

    The only reason I can think of why you would want to redefine the word “inflation” is because you know it has a negative connotation and you want to win people over to your perspective.

  11. Gravatar of ssumner ssumner
    9. July 2011 at 05:47

    Ryan, No, inflation has never been defined as a general increase in the price level relative to the money supply. It’s been defined as a general increase in the price level, or an increase in the money supply. Unfortunately the price level and money supply have never been adequately defined.

    I do not favor high inflation, indeed I think inflation has been too high during almost my entire lifetime. I’d be happy with a policy of 3% NGDP growth, which would lead to near zero inflation. What I want is monetary stability. What we have now is inflation and NGDP growth fluctuating all over the place. We need stability. The actual rate of inflation is of trivial importance by comparison.

    There was no inflation on average between 1921 and 1941–how’d that work out?

    If you think NGDP targeting is pro-inflation, then you obviously don’t understand NGDP targeting. Hayek favored NGDP targeting.

    I never claimed no one is talking about inflation except me–I said others are talking about inflation much too often, but using the term where they should be using a different term.

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