Should we expect (or fear) inflation?

(Open letter to Simon Wren-Lewis)

Dear Simon,

     I like reading, and struggling to understand, your blog posts. But there are two points in your latest post [1] that I would like to query.

Q1. You write: “ All the evidence, direct or indirect, points to the story about fairly anchored long term inflation expectations due to inflation targets and independent central banks being correct.”

 Does this mean: ‘ All the evidence points to the story being correct, that fairly (firmly? appropriately?) anchored long term inflation expectations due to inflation targets and independent central banks.......‘ ?  In which case it seems to me that the sentence in incomplete.

Q2. You find ‘bizarre in the extreme’ any fear about inflation when short-term interest rates approach zero (I do not like the vagueness and jargon of ‘lower bound’): “In that context, and when short term interest rates are at their lower bound, it seems bizarre in the extreme to start worrying about inflation expectations becoming unhinged. “

So your sentence becomes: 

‘When independent central banks control inflation by manipulating interest rates, and when short term interest rates are close to zero, it seems bizarre in the extreme to start worrying about inflation expectations becoming unhinged.‘

     I suppose many people in the UK are not confident that they fully understood inflation as it occurred in the seventies and eighties, when a strongly unionised labour market, forced a wage spiral and induced an expectation of an ever increasing rate of inflation. They fear the apparent loss of control. 

     UK house-price inflation is currently running at 10% p.a. That does not seem to be in accord with the explicit policy of either government, or bank. It suggests that neither agent has a complete grip on the situation (nor even understands fully what it is that the do not grip; supply of land? population? expectations?)

      In the last 12 months the US$ has slumped 10.87% against the Euro, 13.41% against the GB pound, and 16.7% against the Mexican peso. May that be the result of their use of helicopter-money in response to COVID?  That is steep, though I grant that there is no sign that it is “unhinged”. I suppose that expectations, at this stage, are that the dollar will claw its way back up, and that there will be considerable willingness on the part of workers to restrain wages. But we shall see.

      I have been trying (for my own benefit) to tease apart the linked and overlapping concepts of (a) true growth, (b) inflation,  and (c) interest rates [2]. I have some way to go for a solid understanding, and these are topics that call for numerical treatment. It will be noticed that I have not regarded over-night interest rates as a cause of inflation. Such interest rates may operate to manipulate expectations, by indicating (or sometimes mis-indicating) the intentions of the financial authorities.  But it is expectations that seem crucial to understanding inflation, and they elude mathematical treatment; they may not even be rational.

Yours sincerely, Ian West.

(Comments are welcome, direct to cawstein@gmail.com)

References

[1]  https://mainlymacro.blogspot.com/2021/06/how-should-we-think-about-talk-of.html 

[2]  http://occidentis.blogspot.com/2021/04/growth-inflation-and-interest.html

 Another Scottish Referendum?

     I suppose we have to have another Scottish Referendum. The SNP seem to have won the confidence of the Scottish people. And it seems inherent in the political system we have evolved that the First Minister can bring matters to the Scottish Parliament. They will have to judge the benefits and costs, but if that democratic body votes for a referendum, how can it be denied?

     However, I hope we all agree that the disastrous mistakes of the Brexit referendum must first be noted and then avoided. Namely: 

1. There should be complete clarity as to the implications of each conceivable result, as to whether the government is compelled or merely advised by the result.
2. There must be a  very significant majority, perhaps 2/3, perhaps 3/5,  before any suggestion of significant constitutional change be made. 

     It is widely thought that our sovereign parliament should not be bound by a referendum. But it has become clear that parliament is not sovereign, because it is not proportional; it sways madly from side to side due to the crazy voting system. One proof of this assertion is that a referendum was called for in the first place.

     It is also becoming clear that a question of great magnitude should not rest on a slender 52:48 majority. Such an insignificant majority has split the country so nearly into equal halves that it can be plausibly argued that we have got the wrong result. Proof of this is the desperate refusal of the brexiteers to allow a second Brexit referendum. What if 1% of voters changed their minds? What if, in 2 or 5 years’ time, the removal of older voters and the introduction of younger voters changed the result from “out” to “in”. Would we then reverse the enormous task of reordering the constitution, the government, the law, and the economy and accept that we had frittered away a decade for nothing?

     Let us hope that this is so obvious to everyone that it need not be said. For it has not been said yet.