Yglesias: “don’t reify the concept of an inflation rate”
I’ve gotten a lot of flack for making a post-modern argument that inflation was a sort of social construct, not an “actual thing.” Matt Yglesias has actually studied philosophy, and is thus able to express this idea much more clearly:
Social Security benefits (and the like) need some kind of annual adjustment that neither breaks the bank nor guarantees ever-falling living standards for elderly people. So we have an effort to construct a statistical series that will meet those goals. And it works pretty well. But don’t reify the concept of an inflation rate and then worry about whether or not the government is “really” calculating the “real” one. Things change in a lot of ways, preferences are heterogeneous and aggregating it all up into a single number is inherently wrong. It’s just that the programs need a single number.
“Reify”—I need to remember to use that word more often.
In this post I criticized the idea of indexing pensions to inflation, but my post was misunderstood by many commenters. There are actually two issues with Social Security indexation, the initial benefit level, and the subsequent increases in benefits once people are already in the program. In America, the initial payment is indexed to average wage levels, and the subsequent COLAs are indexed to the CPI. This means that as real wages rise slowly over time, the living standards of 65 year olds will rise at the same rate as those who are still working, but then as they get into their 70s and 80s they will see their relative wage fall slightly, compared to younger workers. In practice that’s probably not a big problem as the very old also tend to cut back on activities like trips, and watch a lot of TV. So their costs fall. (Although their health care expenses may rise faster than the CPI, so it’s an open question as to whether the CPI adjustment is adequate.) In addition, real wage increases have recently been quite low.
A few decades back the British tried indexing the initial benefit levels to the CPI (not wages as we do.) Eventually the old people revolted, because as real wages trended upward over time, the living standards of the old fell further and further behind the lifestyle of those still working. One might argue that the US system works just fine, in balancing all the fairness issues I’ve just described. But if so, it’s only by coincidence. My mother-in-law was a Chinese academic, and is now retired. As far as I can tell her pension has risen faster than inflation, and it’s not hard to understand why. In China real wages have risen dramatically over time. If someone received benefit increases merely equal to the rise in the CPI, they wouldn’t feel they were “doing OK.” Rather they’d feel increasingly impoverished relative to the fast rising living standards of those around them (in Beijing, where she lives.)
I’m not sure if this makes any sense, but the bottom line is that the optimal indexing system would look something like the following:
1. Initial pension should be indexed to average wages, not prices, as in the US.
2. Subsequent increases should also be indexed to wages as well, but perhaps with a slight adjustment to account for economies of lifestyle as one ages (perhaps the average wage increase minus 1/2%.)
BTW, I also liked this comment in Matt’s post:
I think this is something that should be kept in mind as the NGDP targeting debate continues. Because the phrase “real GDP” contains the word “real” and because inflation targeting is customary, it’s easy to think of NGDP as something weird that’s constructed of real output plus inflation. The truth is the reverse. Nominal output is something that’s directly measurable. Inflation is a product of a bureaucratic process. And “real” GDP is just nominal GDP minus the output of the bureaucratic process. If bulk commodities (oil, coal, wheat, rice, corn) constituted the bulk of economic output, you might say this isn’t the case. You can measure the quantities of commodities produced and also the prices charged. But the actual American economy isn’t like that. There’s not a fact of the matter about whether the more expensive hairstylist is “really” better than the other one. (Emphasis added)
All you Austrian-types who are distrustful of government bureaucracies should take note of the sentence in bold print. Yes, NGDP is also calculated by bureaucracies, but it doesn’t require so many highly subjective quality judgments.
I started off mentioning “a lot of flack.” That included “friendly fire” from David Glasner. He points to several areas where he thinks inflation is useful. Stocks are positively correlated with inflation during recent years, gold hoarding led to deflation in the 1930s, and there is the Fisher Equation. I would argue that in each case NGDP growth works better than inflation. For instance, deflation is only bad if NGDP falls, otherwise it reflects rising productivity. The correlation between stocks and inflation briefly turned negative when Libyan oil was cut off, and we suffered a “supply shock.” Nominal interest rates correlate with NGDP growth.
I realize I may have pushed the critique of inflation a bit far, but I hope it will force people to rethink their assumptions.
PS. Obviously I’m way behind on comments, but will eventually catch up with older ones.
PPS. I suppose I should allow comments to this post to mention ‘inflation,’ since I mentioned it 10 times. 🙂
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8. November 2011 at 16:11
I don’t think (and I doubt you do either) that economists should completely give up trying to measure the general price level or modeling it in the abstract. But we need to recognize that it becomes a messy concept once we take into account that there is more than one good. And it becomes an even messier concept once we take into account that the subjective “good” of any physical good doesn’t necessarily have a stable or simple relationship to the measurable quantity. And it becomes yet messier when we take into account that many goods are completely new and difficult to compare with pre-existing goods. And since the general price level is such a messy concept, it should be used with extreme caution when there is a much less messy concept available that can do most of the work that needs to be done.
8. November 2011 at 16:18
Inflation doesn’t just happen.
It is easy to have no inflation, after all we have a Central Bank who can do anything!!! There’s no reason to welcome productivity driven deflation. Expecting your money to be worth more in the future, just makes sellers work harder to get your wallet out.
As such, any inflation ALSO carries the disadvantage of forcing us to try and measure it.
Once again, Matty is a half wit.
Inflation is CAUSED BY the Central Bank, so there is reason to deify inflation and valorize productivity gains.
It is all about your mental starting point.
If you start with Society first, you grow half-wits thats make nothing and spout why they should matter more.
If you start with the Individual, you’ll end up with less human suffering.
In between there will be discussion of monetary policy.
But we all KNOW at the end of the day, monetary policy and government itself will serve certain individuals – the ones who are PAYING.
The one thing clear through history, is that no matter the intellect, no matter the artist, no matter the pol – they all have to BEG for their supper.
And beggars cannot be choosers.
And we know that it our bones.
8. November 2011 at 16:20
There’s no reason NOT to welcome productivity driven deflation.
8. November 2011 at 16:21
Andy, there is a way to do it, you just measure commodities. Limited. Same. Like money should be.
8. November 2011 at 16:30
Sure, our measurements of inflation are crappy. But inflation itself is simply a kind of mismeasurement…it’s one way (not the only way!) in which “the actual thing” (NGDP) mismeasures the thing we really care about (RGDP).
http://noahpinionblog.blogspot.com/2011/11/let-them-eat-ngdp.html
It’s like measuring a worker’s time-on-task by measuring how many hours she worked. You know that the easier thing to observe (hours in front of the desk) is different from the important thing (time on task). You know that any attempt you make to “correct” hours-at-desk to back out time-on-task is going to be filled with mismeasurement. But that doesn’t mean you care about hours-at-desk more than time-on-task.
NGDP may be a fine thing for the Fed to target. But that does not make it a goal in and of itself.
8. November 2011 at 16:39
I suppose this is implicit in Harless’s comment.
When I go to the store, I put 2 loaves of bread in the buggy. That is a quantity, like real GDP. I observe the price listed, at $3.50 per loaf. That is a price. When I go to pay, I don’t really pay 3.50 for one loaf and $3.50 for the other. I just pay $7.00. That’s like nominal GDP. But still, the $3.50 is pretty clear and the cashier does multiply them to get the $7.
In modern macro, with one good and a representative agent. The “price level,” is pretty much like the price of bread. Real GDP is pretty much like loaves of bread. It is quite natural to think of them as being multiplied to get nominal GDP.
As Yngles says, we measure the sum of the products (with lots of extrapolating, really.) And then caculate some indexes for the parts, and divide to get the real GDP.
8. November 2011 at 18:06
I agree also with Andy Harless’s comment.
I studied philosophy too; I actually have a PhD in it. But at this point in the debate, trying to muddy up the nominal/real distinction by getting all philosophical about the concept of inflation is just a dodge. And to the extent the concept is muddied up, it only makes the intended aims of the NGDP targeting camp even harder to decipher.
Everyone understands intuitively that when spending of any kind goes up, that can be because we are buying more of certain goods at the same price, or the same amount of certain goods at higher prices; or more likely because of some combination of the two. People might also substitute very different kinds of goods in their purchases for other goods they used to purchase. We would like to understand, for any particular episode of increased spending, which are the proportions of these various factors. It is very hard to come up with a numerical measure by sampling a basket of goods. But that doesn’t mean the concepts should be discarded and no analysis attempted.
8. November 2011 at 18:38
One might argue that the US [SS benefit calculation] system works just fine, in balancing all the fairness issues I’ve just described. But if so, it’s only by coincidence.
The kind of coincidence that occurs after changing the rules time and time again until finally finding a set that satisfy a consensus opinion as being fair enough. Social Security’s rules were changed by almost every Congress from 1939 to 1983 — the benefit payment rules were changed several times over until the consensus was reached.
8. November 2011 at 18:48
The truth is the reverse. Nominal output is something that’s directly measurable. Inflation is a product of a bureaucratic process. And “real” GDP is just nominal GDP minus the output of the bureaucratic process.
Oh, this is pushing things far too far, ISTM. The calculated number purportedly *measuring* inflation is a product of a bureaucratic process. But inflation itself — the decline in the purchasing power of a currency — is real enough, and the product of monetary policy. Ask the people of Weimar, etc.
Saying that because every measure of something is questionable in some way, in no way supports the argument that that thing doesn’t exist in hard reality. (I was a philosophy major in college but pretty much ended up running away from it because of arguments like this.) Hey, if the argument *is* valid then monetarism is refuted from first principles.
The early MMTerfs used to lecture me constantly about this back in usenet days. They made the perfectly credible point that the relevant money supply itself can’t even be clearly defined, with all the various measures of money just produced by bureaucrats and academics. As there are serious questions about every single measure, direct and indirect, and what its implications may be, all monetarist analysis depending on a quantity of money are bogus. There is no quantity of money, as it cannot even be clearly defined, much less measured. So spoke the MMters.
Yet even granting their points, I still believe that increasing the quantity of money by far too much in Zimbabwe created massive inflation — demonstrating the hard reality of both the quantity of money and inflation.
All attempts to measure gravitons and gravity waves have failed too — yet few take that as meaning gravity isn’t real but a mere social construct (although the view has been about).
8. November 2011 at 18:49
Scott
Only tangent to the post. Angry Bear seems to direct most of the “anger” on you. This time they went way back and grossly misrepresent your thoughts:
So…. his story requires the devaluation of the currency to worsen the trade balance, and rational expectations to cause a one time explosion in industrial prices and a rather smaller recovery in consumer prices. Rational expectations, however, that came an abrupt halt, at roughly the same amount of time one would predict companies might decide that demand will be sustained enough to start producing more rather than just selling off inventory sitting in warehouses. And his story doesn’t explain why growth was so much faster during the New Deal era than any other period of peacetime since the US began keeping data, nor why there was the big hiccup in 1937.
Sumner is essentially trying to tell a story about an unusual set of events, but his story seems to assume that most extraordinary events of the era (and what sets that era apart) kind of just happened to occur for no particular reason so he misses the big picture and ends up focusing on details. With all due respect to Sumner, I prefer to think the US economy is not Forrest Gump.
http://www.angrybearblog.com/2011/11/sumner-skidelsky-keynes-and-liquidity.html
8. November 2011 at 19:46
I had a very different reaction to that post. My response was “gee, if only it was possible to set payments at a certain level, then let some group congregate every once in a while, take expert testimony, and evaluate if the payment is high enough or not. But what would we possibly call such an institution…” MY’s boundless belief in technocracy will never cease to amaze me.
8. November 2011 at 20:15
I don’t buy this (one of my majors was philosophy, for what it’s worth). In New Keynesian models, for example, inflation is a perfectly well-defined quantity. If the world we live in was truly a world perfectly described by these models, then inflation would be a concrete thing, like length or volume. In the real world, measuring inflation is hard, because you have to say what is a (large) random sample of the goods and services produced by the economy, what is the average price of one of these goods or services, and how does it evolve over time? That means defining the boundaries between many goods (is a smart phone just a more expensive version of a cell phone or a different good altogether), etc. In principle, I don’t see why this is irresolvable, though in practice it makes measuring inflation meaningfully a challenge.
I think I agree that for policymaking purposes, trying to measure true inflation may be unnecessary, if we focus on nominal GDP, etc. But I think that it’s still perfectly meaningful to say that, for example, faster expected future nominal GDP growth accelerates current nominal GDP growth by raising inflation expectations and thus lowering real interest rates. The difficulty of measuring inflation may make that a harder empirical sell but the story it is telling is perfectly meaningful.
8. November 2011 at 21:42
The peevish fixation on inflation and prices hides a larger truth: For many transactions, it is impossible for the consumer to know what should be the right price or quality of service or product.
Choosing a health care plan? Good luck. How about buying a car? Computer? Dentist for surgery? Buying a house is way over your head, I guarantee it.
And in areas where the consumer does have a pretty good grip on quality and price—groceries for example—some inflation would not really harm the consumer. I know what chickens should cost within a few dimes a pound (due to competition), and mild inflation will not harm my ability to figure that out.
My point is that economic growth is much more important than rigidly controlling nominal prices.
8. November 2011 at 21:51
Scott, sort of argument you make about the inflation rate has nothing to do with “post-modern philosophy”.
It’s an OLD argument WITHIN economic science.
See for example Gottfried Haberler’s famous _Der Sinn der Indexzahlen_ 1927.
Haberler taught for years at Harvard & studied with Wieser.
I.e. he comes from the core of economic science since the marginalist revolution.
But of course Haberler wasn’t an idiot. He participated in Hayek’s private seminar and Mises’ private seminar, which tackled the hardest conceptual issues in economic science and the wider world of ideas & science.
As Hayek often put it, an economist who is only an economics is not a very good economist.
Thinking carefully and soundly about concepts like “inflation” is all about being a good scientist.
It has nothing to do with “philosophy” as you would study it in most classes in college.
8. November 2011 at 22:53
@Scott,
I think you are confusing the concept “inflation”, which is easily defined as rising prices, and the various attempts to measure the magnitude of inflation.
Rising prices matter, and the extent to which prices are rising matters.
There is no one correct measure of rising prices, and we shouldn’t talk as if there is one. For one thing, the goods and services being priced change each year. There was no iphone 10 years ago.
However it makes sense to measure rising prices in various ways, as part of our monitoring of the economy. None of these particular measures should be taken as the definitive “inflation rate”, but nevertheless it is important that the measurements be made. A large proportion of goods and services do not change dramatically in kind from one year to the next. There are basic items that we all need to survive, and price changes in these can have dramatic impacts. We did have bread and oil ten years ago, and iphones are not a survival good (despite claims to the contrary).
There’s no point aiming for an NGDP growth of 5% per year if the measures leading to that growth also lead to prices that rise approximately 7% per year, give or take a percentage point or two depending on how you measure.
The fact that there is no definitive way to extract an objective 7% measurement does not mean that the rising prices should not be monitored at all. It’s also not a good reason to suppose that targeting NGDP growth will lead to a healthier economy than targeting a measure of prices.
I understand your point that when people use the word inflation it is not always clear whether they mean the concept itself, or a particular measure of rising prices. Often times the meaning can be discerned from the context, but sometimes not.
However, this is the case with many, many words and other language constructs. If we banned the use of all words with ambiguous meanings, there would be little left with which to write. Much of the meaning comes from the context of the words, and through clarifying discussion.
9. November 2011 at 00:18
[…] “Don’t reify the concept of an inflation […]
9. November 2011 at 05:21
My grandfather remains a retired college instructor/administrator, which he’s been for over 30 years. In fact, his life was divvied up into thirds: 1/3 before work (including WW2), 1/3 working and 1/3 retired. He’s (I think?) 90 right now. He is often amazed at how his living standard has skyrocketed since he retired. His pension is indexed to wages.
9. November 2011 at 05:57
Andy, I can only see one use for the price level–as a way of measuring living standards. But as we see in the debate over Tyler Cowen’s “Great Stagnation” hypothesis, economists can’t even agree on whether growth in living standards is slowing sharply, or isn’t slowing sharply. Which means they basically ignore the CPI and just go with their gut.
Morgan, Measuring commodities gives absurd answers. Did we have 50% deflation in 2009? Was the real return on holding cash in 2008-09 100%.
Noah, You said;
“NGDP may be a fine thing for the Fed to target. But that does not make it a goal in and of itself.”
In a previous post I pointed out that almost all the problems we attribute to inflation are actually due to something else (NGDP or RGDP.) I claimed we should stop talking about inflation.
NGDP is partly an end (nominal stability), to reduce what’s often called the “welfare cost of inflation.” And also a means to an end–less instability in employment. The Fed should pay no attention to RGDP. The mandate is inflation (picked up by NGDP) and employment.
Bill, But economic sgive us no guidance as to how we should construct price indices.
Dan, My argument is that when people talk about inflation, they are almost always talking about the wrong concept, given the analysis they are doing. In almost every case NGDP or RGDP would be better.
Jim Glass, Good point about SS.
MMTers are wrong about money. There are different monies, but the monetary base (which is all the QTM needs) is very easy to define and measure.
There’s a difference between error in measurement, and not even have the variable defined in such a way as that we know what we are measuring. People usually start by imagining a single simple good, and then say we should use the same idea for the overall price level. But that’s a non-starter, as we can’t use the same technique for the overall price level, unless we give equal weights to cars and toothpicks.
Marcus, I have only read your excerpt, but already he’s way off base. FDR devalued the dollar, which was highly expansionary even though the trade balance got “worse.” So he obviously doesn’t understand my ideas.
Cassander, I read they are now considering adjusting the CPI (to chain weights) to slow down SS increases.
Ram, I don’t think you appreciate the theoretical difficulties here. At the deepest theoretical level, inflation is the income increase needed to hold utility constant. OK, but surveys show that the happiness of Americans hasn’t increased in many decades. So RGDP hasn’t increased. Is that your view? Ultimately (according to economic theory) inflation is about utility, not things. But economists really have no good model of utility.
Benjamin, I agree.
Greg, Glad to know Haberler was a post-modernist.
Paul, You are wrong about inflation, it is not well defined–see my answer to Ram.
You said;
“There’s no point aiming for an NGDP growth of 5% per year if the measures leading to that growth also lead to prices that rise approximately 7% per year, give or take a percentage point or two depending on how you measure.”
Wrong. You’d want 7% inflation in that case. Because the harm most people think is caused by inflation, is actually caused by NGDP growth. So NGDP growth is the thing you want to control.
DW, Good point, as real wages trend upward over long periods of time. That’s why I’d use real wages minus X%.
9. November 2011 at 08:10
All concepts are precisely as real as the best (most useful) predictive model that needs them. ‘Nuff said.
Do people do better by using the concept of inflation in their planning for the future? Yes, because no one feeds you information in real terms, only nominal.
9. November 2011 at 08:29
Last year our RGDP was 1 apple; this year it is 1 orange. So did it go up or down?
RGDP is not a real thing if you define real as “can be measured”. I know that’s an odd definition of real but it seems to explain why people use the nonsensical equation
NGDP = RGDP x price level
9. November 2011 at 08:45
On pension indexing: Any defined benefit plan is just hope masquerading as a promise. Indexing to wages puts the pension plan one step further from defined contribution, and one step closer to ponzi scheme.
If social security were explicitly a transfer program this would be irrelevant; it’s a political choice for today’s workers to top-up savings of retired workers. But since we’re pretending (and accounting) that older workers really earned their benefits, it’s not right to also pretend that their savings somehow grew just because younger people are making more money now.
9. November 2011 at 09:20
Scott,
Isn’t the price level also useful as a means of measuring the price of money?
9. November 2011 at 09:36
[…] Andy Harless agrees with some of my points, but argues that inflation is still needed for certain purposes. I don’t think (and I doubt you do either) that economists should completely give up trying to measure the general price level or modeling it in the abstract. But we need to recognize that it becomes a messy concept once we take into account that there is more than one good. And it becomes an even messier concept once we take into account that the subjective “good” of any physical good doesn’t necessarily have a stable or simple relationship to the measurable quantity. And it becomes yet messier when we take into account that many goods are completely new and difficult to compare with pre-existing goods. And since the general price level is such a messy concept, it should be used with extreme caution when there is a much less messy concept available that can do most of the work that needs to be done. […]
9. November 2011 at 14:34
@Scott:
I said: “There’s no point aiming for an NGDP growth of 5% per year if the measures leading to that growth also lead to prices that rise approximately 7% per year, give or take a percentage point or two depending on how you measure.”
You replied: “Wrong. You’d want 7% inflation in that case. Because the harm most people think is caused by inflation, is actually caused by NGDP growth. So NGDP growth is the thing you want to control.”
So the harm in the case above is caused by the 5% NGDP growth? What do you suggest the NGDP target should be?
Do you see no difference between a case of 5% NGDP growth with 0% CPI, and a case of 5% NGDP growth with 7% CPI?
10. November 2011 at 19:44
Silas, I just have a different version of “real.”
JJ, Good point.
W. Peden, Maybe, but that begs the question of “in terms of what good?”
Paul, You misunderstood me. I think NGDP growth should be 5% regardless of inflation.
Yes, I think we are better off for any given NGDP growth rate if RGDP growth is higher.
10. November 2011 at 20:13
@Scott,
You said: “Yes, I think we are better off for any given NGDP growth rate if RGDP growth is higher.”
Isn’t this another way of saying that you think we are better off, for any given NGDP growth rate, if inflation is lower?
12. November 2011 at 08:26
Post modernism is a pathology.
It is worse than what it replaced.
I recommend Wittgenstein and Kuhn and Hayek as remedial education.
12. November 2011 at 14:23
Paul, Yes.
Greg, That’s for the tips.
12. November 2011 at 16:01
@Scott,
Given that you agree that 5% NGDP growth with 0% CPI increase is better than 5% NGDP growth with 5% CPI increase, would you agree that 2 decades of 3% NGDP growth with 1% CPI increase is better than 2 decades of 5% NGDP growth with 5% CPI increase?
13. November 2011 at 11:02
Paul, Yes. Fewer keystrokes would have been required to ask me whether 2% RGDP growth is better than 0%.