Shostak on The Importance of Theory

Shostak on 'The Importance of Theory'.

In “Fed confused about what drives inflation?”, Dr. Frank Shostak writes:

“The purpose of a theory is to enable to ascertain the definition of a phenomenon that is subject to investigation.
    The correct definition attempts to identify the essence of the phenomenon i.e. the key parts that drives the phenomenon.
    For instance, the definition of human action is not that people are engaged in all sorts of activities, but that they are engaged in purposeful activities – it is purpose that gives rise to an action.
    So when Tarullo states that Fed policy makers do not know the causes that drive inflation he basically says that Fed policy makers have not as yet established the correct definition of inflation.
    Is it then valid to be practical, as suggested by Tarullo, to focus only on the data to understand what inflation is all about? If Fed policy makers respond to changes in price indices without establishing what drives these changes this runs the risk of making things much worse.”

My literal translation (into English).

The reason for propounding a theory is to make possible the definition of the phenomenon under investigation. A correct definition identifies the essence of the phenomenon, i.e. the forces that drive the phenomenon. For instance, the correct definition of “human action” indicates that activities are purposeful, not merely varied; for it is the purpose that gives rise to the action.

So, when Tarullo states that policy makers at the Federal Reserve do not know the causes that drive inflation, that is tantamount to saying that they have the wrong definition of inflation. Is it then valid to focus only on the data (as a means of understanding the ‘meaning’ of inflation)?  To react to change in the Consumer Price Index without understanding what is causing those changes could make matters worse. 

My Comment

I do not think the reason for propounding a theory is the one given, and I disagree with Shostak’s definition of “definition”, and (in addition) his definition of “human action”. But this nonsense is not germane, and perhaps can be safely ignored. I agree with Shostak that the Federal Reserve should try to understand the cause (or causes) of any current inflation. 

It may be that inflation indicates that something is changing; the volume of money, or of goods. An intelligent Government would try to identify what exactly is changing, and adjust for that. They should not merely obliterate the signal. There is a parallel in healthcare. Pain is a signal of something going wrong. An analgesic like paracetamol obliterates the signal but does nothing to identify precisely what is going wrong, and nothing to rectify the problem.

Dr. Shostak is angry about inflation because it robs value from those with positive bank balances. But there will (presumably) be others who like inflation because it gives value to those with negative balances, and those who create the money. 

But let us get back to the "importance of definition". Dr. Shostak writes:

"However, if we accept that inflation is about rises in money supply and not a rise in prices then all ........ can be easily explained.  It is not the symptoms of a disease but rather the disease itself that causes the physical damage. Likewise it is not a general rise in prices but rises in money supply that inflicts the physical damage on wealth generators."

Once again  I disagree. I believe that the money supply should increase as and when necessary, for example, when there is an increase in goods. 

But there is a quite different, and much more subtle argument in favour of a controlled low level (2%p.a.) of inflation. Is the Keynesian position not generally accepted that, for psychological reasons, an economy is more stable and more easily controlled when there is a constant low level of inflation? Do we throw out the "General Theory" and 8 decades of largely successful government for the sake of simple mathematics? I do not think the case is made, yet.  

Maybe we could agree that, as a type of covert taxation, inflation is a bit underhand.