Wednesday, July 30, 2014

Figuring out the Inflation Vigilantes

Brad DeLong provides the raw material, and Paul Krugman adds some speculation to an account of unrelenting and unapologetic error on the part of those who would scare us about inflation, always just around the corner.  Here are two further thoughts to chew on.

1. The paranoia about inflation is a widespread, longstanding phenomenon, with immense influence over public discourse and economic policy, and out of all proportion to the actual—and very history-specific—threat.  It deserves to be studied by the normal tools of social science, the ones we devote to other significant political, religious and social ideologies.  Obviously, political economy has a key role to play, insofar as net creditors, as a rule of thumb, benefit from less-than-expected inflation.  (I give this a short treatment in my introductory macro text, due to be released in about a week.*)  But I’d like to see the full range of analysis: social psychology, networks of influence, case studies, and any other tools that can replace speculation with solid understanding.  The disinflation lobby is an important part of the political landscape and deserves careful study.

2. One aspect of the IV impact on our discourse that has particularly rankled me as an economics instructor is the deliberate propagation of what I call Type II money illusion.  (Does anyone else use this terminology?)  Type I is carefully explained in every introductory textbook: if you look only at your money income and ignore changes in the price level for the goods you buy, you will overestimate your true spending power.  Governments are said to rely on this confusion when they engage in expansionary monetary policy, and one of the functions of Econ 101 is to innoculate the masses against it.

But there is also the reverse error, to observe changes in the price level of consumption goods but not the (roughly) corresponding increase in money income.  This is circular flow stuff, as fundamental as it gets.  It is an error for the public to think that a rise in inflation makes them, considered together, poorer—as if, with lower inflation, everyone would continue to get the same wage hikes and enjoy the extra consumption.  Seeing the spending side of inflation and not the income side is Type II money illusion.

The interesting thing is not simply that lots of people (in my experience even a large majority) harbor this, but that it is actively purveyed by the media and even, on occasion, prominent members of the economics profession in their popular writings.  “Good news for consumers!  The latest report shows that inflation has come in below market forecasts.”  “Inflation is the cruelest tax of all.”  You know the drill.  And that is exactly the way it works: it is drilled in, over and over, until money illusion becomes the shared reality and the few of us who recognize it as an error find ourselves reduced to shouting at passers-by (or at least our students), like incomprehensible fanatics.

I mention this partly to vent, but also because I think this massive, systematic disinformation really deserves to be studied.  Why does it persist?  Why do the economics textbooks not bear down on it like they do against Type I, even though far more people today are in the grip of this second kind of illusion?  Political economy surely plays a role, but only indirectly, since most of the confusion is purveyed by people, like journalists and your Republican cousin at this summer’s family reunion, who have no direct interest one way or the other.

Note: I’m sure some people will read the above and immediately try to argue that inflation really does eat into spending power through a wealth effect.  That’s a separate discussion (it could be true, but it doesn’t get rid of Type II money illusion, which is quite specific and impossible to defend), but note that wealth channels get complicated: you have to consider net and gross debtor and creditor positions, financial versus real assets, nominal versus real exchange rate movements for internationally diversified portfolios (and the degree to which these are baked into asset prices), and so on and on.  Trust me: that’s not what most people are thinking about when they burble that of course inflation is bad because it reduces your real income.

*Don’t worry about the announced release date; I’m told it is imminent.  And, no, it's not 109 pp.  Closer to 4x.

12 comments: said...

Congrats on the book finally coming out, :-).

Peter said...

I've wondered about this too. I'd guess it has something to do with what Krugman says about being anti-government and "pro-free market." Same with the gold bugs.

Then there's Robert Lucas who is quotes as saying "we already tried inflation in the 1970s!"

So there's the sense that inflation is just the government trying to get a free lunch and you just get stagnation as a result.

Krugman blogged about he recent U. of Chicago survey where most of the economists surveyed said the stimulus worked. The economists' consensus is just not getting out to the public as must be the case with the Type II money illusion.

I remember very well how Mankiw and Rogoff advised raising the inflation target but then quickly shut up about it. The problem is Republicun economists who provide the cover of respectability to conservative economics.

Jeff Young said...

Well, I can think of two explanations immediately. First, which comes first, to me? Rises in my prices or a raise in my salary? Presumably if we're coming out of a demand slump, the price rises need to come first? And only once businesses feel secure in the permanence (sustainability) of that will they raise wages/hiring.

Second and related, price rises happen immediately and continuously. I only get a raise once a year.

In other words, it doesn't matter how it works at the macro level, when people can tell a good convincing story about the individual level.

Jeff Young said...

I thought of a third point, along the same lines. Profit-maximizing price setting for a business is largely an automated and quick-implementation process. In order to get my optimized salary, I need to engage in lengthy PITA personal negotiations and self-promotions AND be continuously and publicly prepared to make hugely life-disrupting job moves if/when the higher salaries are only available outside my current job.

Again, these are just not comparable as economists' equations would have them.

bakho said...

Inflation is presented by the media the way the Malefactors of Great Wealth want it presented. You will only ever hear talk of prices going up. You never hear talk of wages going up. Efforts to raise the minimum wage are always a fight against Cheap Labor advocates who expound on the evils of paying labor a fair wage. The Malefactors want cheap labor. They want to increase their own profits and not distribute any more than they must to the labor that produced it. They know that when the Fed acts to keep prices down, it works through income reduction and higher unemployment to keep wages down. This is what the Cheap Labor Malefactors want.

Sustained inflation requires wage inflation as well as price inflation. Wage inflation benefits those who are trying to deleverage at a cost to their creditors. Creditors notoriously pursue short term profits and promote low wages and wage increases even if it leads to more investment defaults. They can always foreclose. The Malefactors of Great Wealth seek to make it harder to default on debt through the regulatory process rather than raising wages to reduce the need to default. In the Great Recession, even though we had millions of overleveraged individuals who could have been helped by wage inflation, that path was denied. The banksters apparently prefer to foreclose and go into the rental business than allow an economic climate where more of the wealth flows to wages.

People in general are snookered by the argument, "We can't raise the MinWage because the price of everything will go up!" True but in the nuanced view a McWorker would receive $ thousands more per year and the price of a burger would rise by a nickel. The Malefactors can buy a really loud megaphone and shout over the opposition to produce a one sided debate.

Sandwichman said...

"massive, systematic disinformation really deserves to be studied. Why does it persist?"

Deserves to be studied? Well excuse me but the Sandwichman actually studies the massive, systematic persistence of discredited ideas. It may be a little hard to find because I post my results right here to EconoSpeak where Mark Thoma does not link to them ;-).

Long story: the "demon" in supply creates its own demon is the horse the inflation vigilantes ride to their rendezvous.

Short story: "Why do defunct ideas persist? Hypothesis: they fit into a multi-faceted repertoire of beliefs and behaviors in which they 'make sense' because they legitimate and rationalize those beliefs and behaviors. It's no use refuting the wrong idea without directly confronting its repertory context."

Peter Dorman said...

Just to clarify, there are plausible stories out there to explain why this particular macroeconomic error has legs. Like I say, I've put out one or two myself. But there's a difference between hypothesizing and really studying. I'd like to see a whole literature -- you know, case studies, lab experiments, econometric tests, the whole works -- carefully examining the origins, persistence and spread of Type II money illusion. Think of the literature on climate denialism, for comparison. There's a big practical payoff from knowing the dynamics of this stuff in depth.

Eric Blood Axe said...

It would be nice to try no inflation for 20 years and see what problems develop.

Sandwichman said...

"But there's a difference between hypothesizing and really studying."

What are you saying, Peter? That this literature doesn't exist because you don't know about it? I too would like to see "a whole literature." The way that starts is by people paying attention to what is already there (but is ignored because it isn't yet "a whole literature'.)

McCloskey and Ziliak's study of the misuse of statistical significance is relevant. So is John Quiggin's discussion of "zombie" economic theory. There is also value (I would claim) in a literature review of the historical refutations of the "error with legs."

Are you saying that case studies and literature reviews are "hypothesizing" and "not really studying"? If so, would you please elaborate on what that difference is and on how we get from here to there without acknowledging that there actually is a here?

Peter Dorman said...

S-man, if there really is something out there, I'd appreciate a reference. Seriously. But general discussion of methodological error (McCloskey and Ziliak) and content refutation (Quiggin) is not what I'm talking about. Again, consider the climate denialism analogy. We now have studies that look at the funding of denialist groups, analyze their strategic documents, identify covariates at the level of individual opinion formation (authoritarianism etc.), test cross-national hypotheses, and on and on. Denialism is an object of study. Hell, libertarianism is an object of study, with books on Mt. Pelerin, lab experiments in contextual factors that elicit libertarian/self-regarding values, etc. So I'm just asking to add another object of study.

Sandwichman said...

At the risk of shameless self-promotion, Peter, may I mention:

"The lump of labor case against work-sharing: populist fallacy or marginalist throwback?" in Working Time: International trends, theory and policy perspectives, edited by Lonnie Golden and Deborah M. Figart.

"Why economists dislike a lump of labor." Review of Social Economy, 65, 3, 2007.

"Missing: The Strange Disappearance of S. J. Chapman's Theory of the Hours of Labour." Unpublished conference presentation, 2007.

"Identity, Metamorphosis, and Ethnographic Research: What "Kind" of Story Is 'Ways with
Words'?" Anthropology & Education Quarterly, 22, 1, 1991.

I mention the last one only as evidence of my heretical methodology: narrative ethnographic analysis.

What I do is investigate the "ethos" or cultural ways of economists, based on the distinctive narrative features of the stories they tell. This is not the kind of research I would recommend to an academic interested in building a career record of publications in highly-ranked journals, especially in the field of economics.

One of the findings of my research, if I may summarize it in such informal terms, is that academic economists are complicit in the persistence of what you call "systematic disinformation."

You mention the fact that "economics textbooks do not bear down on" the error you call Type II money illusion. I would argue this is not some random oversight but is the product of internalized professional expectations and constraints. Ironically, this can be viewed as an instance, by economists, of what Frederick W. Taylor termed "systematic soldiering." Or, shirking, to use the terminology of Shapiro and Stiglitz.

To put it bluntly, there are very formidable economic incentives for economists to not do economics when that would entail reflection on the professional pathologies of economists. Veblen wrote about this a century ago in The Higher Learning in America. It didn't magically disappear just because he wrote about it!

Sandwichman said...

BTW, in case yer wondering what the lump of labor fallacy has to do with "inflation vigilantism," please be advised that the second instance of the fallacy claim cited in my 2000 paper deals with Layard et al.'s contention that cuts in hours might initially lower unemployment but only at the cost of increased inflation!

Blah, blah, NAIRU, blah, blah, blah, blah, blah, blah, blah, blah, NAIRU, blah, blah, blah, blah, blah...