Sunday, November 21, 2010

The Political Economy of the Inflation Hawks

Brad DeLong asks an interesting and very pertinent question: what are the motives behind those who are screaming that the Fed is stoking the fires of inflation?

Brad’s comparison of olden times, before WWII, and today is worth quoting. Then:

There was then a hard-money lobby: a substantial number of very rich, socially influential, and politically powerful people whose investments were overwhelmingly in bonds. They had little--personally--at stake in a high level of capacity utilization and a low level of unemployment. They had a great deal at stake in stable prices. They wanted hard money above everything.


Today we have next to no hard-money lobby, for nearly everybody has a substantially diversified portfolio and suffers mightily when unemployment is high and capacity utilization and spending are low.

Why then does there appear to be such a powerful, well-healed constituency for restrictive monetary policy in the face of persistent high unemployment? I don’t claim to know the answer, but here is my speculation:

1. Bonds continue to play a very important role in the portfolios of the well-to-do. Hard money remains a significant desideratum for them, although it might be offset in other respects.

2. There is little systematic relationship between equity prices, much less more sophisticated derivatives, and macroeconomic conditions, certainly nothing approaching the strong relationship between bond prices and monetary policy. (This is net of sovereign default risk, of course.)

3. To the extent there remains a relationship between macroeconomic performance and non-credit assets, it is obscured by the tremendous variation across individual portfolios. Investors can tell themselves their profits in good times are due to smart trading strategies, and their losses the result of inevitable mistakes.

Above all of this, I think it is too simple to reduce ideology to immediate self-interest. The ideas people are inclined to believe in are those which appear correct from the social position of the believer, or which foreground the problems that people in this position commonly face. For instance, there is nothing illogical about the fear of wealthy individuals that the governments which borrow from them may resort to inflating away their debts or at least give insufficient consideration to that possibility. They are right to worry about this as a potential conflict of interest: government as borrower and as controller of monetary policy. At the moment, I agree that the risk of excessive inflation pales beside that of insufficient inflation, but in part this is because I am not as fearful that central banks will fail to respond to signals of a recovery if one actually materializes. I recognize the potential conflict of interests that hard money people fret about, but I do not foreground it as they do. This difference between me and them could be called ideological in the social-science definition of that term.

On top of this, ideas have to fit together. The hard money view is an extensive belief system, incorporating distrust of discretionary monetary policy, ethical judgments of the virtue of savers and the sins of borrowers, and the conviction that only the discipline of tough, unshielded consequences can provide a sound foundation for the functioning of a market economy. This frame of mind may be so enveloping that those who subscribe to it may oppose bailouts that are in their immediate personal interest. (But human creativity can also be directed at the search for exceptions and loopholes....)

To put it simply: the ideology of hard money, as opposed to the immediate interests it generates, is not calibrated to the direct costs and benefits of economic policies. It reflects instead an intellectual orientation that is reinforced by the experiences and interests of the wealth-holding class as they have accumulated over time and can sometime lead to policies that may harm their portfolios in the short run, as opposition to the current round of quantitative easing may do. The natural selection of beliefs, like that of species, operates in the context of structural factors—the interrelationship between concepts/traits—and does not necessarily optimize over each individual element.


john c. halasz said...

If you're liquid in a crisis, you have "hard" money and can snap up devalued assets on the cheap. Most great wealth has resulted from such consolidation, and the mega-rich assume that they can always prosper from manipulating speculative boom and bust cycles. Besides which a declining price level magnifies accumulated stored wealth, even if it signals declining future profit levels. At any rate, the aim of concentrated capital is not to maximize output or optimize social welfare, but rather to maximize the distribution of output to profits over wages and thus the valorization of capital stocks. And there is an element of static monetary illusion at work: a higher relative rate-of-profit not only increases the "value" of capital and of the capital/output ratio, but since lower wages are the obverse of higher prices, the nominal value of total output will seem to be relatively higher. Capital will tend to prefer current profit-max to undertaking the work of raising productivity and conceding sufficient wages to accommodate required AD increases, thus incurring competitive risks to its dominant positions. The contradiction is that higher relative profits require reduced wage-based demand, which reduces the absolute amount of potential profits. So maybe economics should give up it pretensions to universality, as if capitalism tended toward any social welfare optimum.

Anonymous said...

Without a doubt there is a miserly element to the gold folks. But by themselves they could never get Sarah Palin on their side.

The Keynesian project of spending and easy money is just done. Everybody knows it wipes out your salary, wage, and savings. What replaces it will depend on convincing leadership for new ideas.

The Democratic bowing before discretionary monetary authority is distasteful to me. It certainly doesn't help the little guy. And it looks an awful lot like bowing to military authority around Iraq.