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

What is Wrong with Macroeconomics

Macro Mess

     People complain that macroeconomics is a confused mess. It is said that macroeconomists disagree among themselves, that the government is pursuing the wrong policies, that the opposition is not mounting an effective opposition. 

     Diane Coyle in 2012 put the case in a well argued lecture (1), and again in a shorter, less formal, way in a passionate blog (2). Jonathan Portes, in his rebuttal blog (3), summarizes Coyle’s case succinctly as:  

a) "although macroeconomists will insist that there are known scientific facts, they do not appear to agree on what these are”,

b)" the discussion among macroeconomists is so shouty”,

c) "all economists need to do far, far better at explaining their work to the general public”.  

Portes partly rebutted each charge, but in doing so seems to concede each, in large part. 

     That was in 2012; but the argument persists. Last month ‘Unlearning Economics’ (4) weighed in against macroeconomists, and last week Simon Wren-Lewis rushed to his own defence in Mainly Macro (5). But now the argument brings in the extra dimension of politics. Both these bloggers assume ‘progressive’ means ‘distributing downwards the benefits of labour’, and is ‘good’, while ‘regressive’ means ‘reinforcing the power of capital’ and  is ‘bad’. 

     It seems rather pompous of me to join this learned debate, but I have a point or two of my own that I want to make. In my own field of expertise I have seen intellectual tribalism, and well understand a reluctance to grapple properly with alternative ways of rationalising the data. “Intellectuals”, my illustrious colleague often said, “seldom  concede; but they do eventually die”. Natural scientists can usually (in time) be shamed into testing their theories against data; arguments can only persist if both theories are able to rationalise the facts. Does this hard filter operate adequately in macroeconomics?

     However, much of the argument is occurring at levels less rational than the purely academic; between politicians, business men, media commentators, bloggers and the average voter. There are hidden agendas, and consequent confusion, not only about the means, but about the objectives of government policy. Are we trying to increase GDP, or actually trying to reduce taxes; trying to decrease unemployment, or secretly trying to increase it (to bring down costs)? Are we seriously trying to bring down the cost of housing when we ourselves have houses and are getting rather rich thereby, or are we trying to increase profit margins in the industry? Are we simply trying to win an election?  Even phrases like ‘fair taxation’ sow confusion, for some will think it means making the relative burden equal across the spectrum of wealth, while others may think it means we all pay the same absolute amount, like the 'poll tax'. 

     

     It alarms the laymen when they see professors of economics disagreeing (6) and calling each other idiots (7).  It is fair to say that the subject matter of the discipline is complex. But most cutting-edge academic work is complex, and effectively closed to the layman. Macroeconomics, however, is additionally hampered by a traditionally cryptic exposition. Keynes was obviously very clever, which enabled him to conceive the most convoluted and arcane pronouncements (8). Imagine the thrill of finding that your academic competitors do not see the relevance of IS-LM. You will need to explain it! (9), but not clearly enough to be understood; you do not mention what I,S,L and M signify, do not explain that the graph is rotated 90º and uses jumbled axes. (c.f. wikipedia, and https://www.youtube.com/watch?v=mTr2PVbbpxg). 

     Yet there is a simplicity in macroeconomics, as in most things, if you have a mind simple enough to see it. Suppose government wants businesses to produce more goods and employ more men, so that more people have more money and buy more goods. It urges the Bank to lowers interest rates. The people with money buy, those without money borrow and buy. The businesses borrow and build, take on workers, who in turn can now buy goods. Success! But what if interest rates are already near zero? And still people are not buying. (There is clearly no requirement for cash, no point in building factories, no confidence in the near future.) What does 'Marcoeconomics’ suggest? "Fiscal loosening”, says Krugman; but does he mean increasing government spending, or lowering taxes to leave more money in the people’s pockets, both of which increase public debt? (See Chick and Pettifor, 10). 

Now here comes the real problem. What does government do but cut Government spending, and flood the banks with ‘quantitative easing’. (Hadn’t we just established that it was not money we were short of but ‘demand’, and confidence?) The rich get richer, and the poor get poorer, and there is barely a flicker of a recovery. The bosses can invest in new plant! — but there is no point, as there are no customers, no demand.

It is not so much that ‘Macro got it wrong’ as ‘Macro got ignored’. But Macro did get it wrong, twice. It failed to get its point across to those who would have heeded. And in my opinion cutting taxes is not remotely as effective as increasing taxes and increasing government spending; it is merely easier. (See my “Tax and Spend”, 11).  There was no need to scare the public by increasing public debt; and therefore no point in advocating it. Crikey! 

References:

(1) https://www.bnc.ox.ac.uk/downloads/news/tanner_lecture_2012_text.pdf

(2) http://www.enlightenmenteconomics.com/blog/index.php/2012/06/a-macroeconomist-tells-me-off/

(3) http://www.niesr.ac.uk/blog/macroeconomics-what-it-good-response-diane-coyle#.WNkH0GU0mdE

(4) https://medium.com/@UnlearningEcon/no-criticising-economics-is-not-regressive-43e114777429#.iwfjl01sl

(5) https://mainlymacro.blogspot.co.uk/2017/03/on-criticising-existence-of-mainstream.html

(6) https://krugman.blogs.nytimes.com/2016/12/24/dont-blame-macroeconomics-wonkish-and-petty/?_r=0

(7) https://www.forbes.com/sites/timworstall/2016/12/25/paul-krugman-gets-his-recessionary-macroeconomics-wrong-again/#5cc30754701e

(8) http://occidentis.blogspot.co.uk/2014/06/keynes1.html

(9) https://krugman.blogs.nytimes.com/2011/10/09/is-lmentary/

(10) http://www.debtonation.org/wp-content/uploads/2010/06/Fiscal-Consolidation1.pdf

(11) http://occidentis.blogspot.co.uk/2016/07/tax-and-spend.html