Whatever Happened to Inflation?
A look back at controversial predictions about monetary policy
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GoogleSince 2008, the Federal Reserve has been trying to stave off economic disaster with an unconventional monetary policy tool known as quantitative easing. By buying financial assets from commercial banks and other institutions, the Fed has massively expanded the money supply-quadrupling it since the practice began.
Many economists, particularly followers of the Austrian school, deplored the practice and predicted that the unprecedented currency and asset price manipulation would lead to huge and damaging price inflation. reason was among them, declaring on our October 2009 cover: "Inflation Returns!" A group of free market economists were asked: "Has the time come to stockpile canned goods and pick up a wheelbarrow for transporting currency, or should we be afraid of the opposite-a prolonged contraction that causes prices to crash?"
Six years later, official consumer price index inflation sits at just 2 percent annually from July 2013 to July 2014, the latest period for which figures are available. This is identical to the rate for the previous year.
We asked four economists and market analysts to revisit what they originally predicted would happen after quantitative easing and assess whether (and why) they were right. Analyst Peter Schiff sticks to his guns, saying that any "claims of victory over inflation are premature and inaccurate. Inflation is easy to see in our current economy, if you make a genuine attempt to measure it." Economist Robert Murphy believes we are in a "calm before the storm" and is "confident that a day of price inflation reckoning looms." Contributing Editor David R. Henderson writes that the "financial crisis has brought such major changes in central banking that uncontrolled inflation from discretionary monetary policy is not as great a danger as it once was," though he remains critical of the Fed's growing powers. And economist Scott Sumner claims victory for the "market monetarists," noting that both Austrians and Keynesians have been proven wrong by events, and urging both sides to "take markets seriously."—Brian Doherty
Where Is the Inflation?
Peter Schiff
Back in 2009, when the federal government began running trillion-dollar-plus annual deficits and the Federal Reserve started printing trillions of dollars to buy Treasury debt and subÂÂÂprime mortgages, economists debated whether much higher inflation was inevitable. Mainstream economists (who hold sway in government, the corporate world, and academia) argued that as long as the labor market remained slack, inflation would not catch fire. My fellow Austrian economists and I loudly voiced the minority viewpoint that money printing is always inflationary-in fact, that it is the very definition of inflation.
Today, with price inflation still not rampant, it's hard to ignore the victory chants coming from the White House press room, the minutes of the Federal Reserve's Open Markets Committee, the talking heads on financial television, and the editorial pages of The New York Times. They claim that the Fed's extraordinary monetary policy and the government's fiscal stimulus have succeeded in keeping the economy afloat through the Great Recession without sparking inflation in the slightest. Deflation, they argue, is still the bigger threat. Their claims of victory are premature and inaccurate. Inflation is easy to see in our current economy, if you make a genuine attempt to measure it.
The Consumer Price Index (CPI) doesn't qualify as a genuine attempt to measure inflation. The CPI report for July 2014 came in at 2.0 percent year-over-year. But because of consistent alterations in how the data is calculated, the CPI has hidden price increases under a blanket of subjective "adjustments." While the details are intricate, the results can be glaring.
For instance, between 1986 and 2003, the CPI rose by 68 percent (about 4 percent per year). Over that 17-year period, the "Big Mac Index," a data set compiled by The Economist that tracks the cost of the signature McDonald's burger, rose at a nearly identical pace. Since then, this correlation appears to have broken. Between 2003 and 2013, the Big Mac Index rose more than twice as fast as the CPI (61 percent vs. 25 percent). The sandwich, which reflects the average person's direct experience, may be a more accurate yardstick of inflation.
Meanwhile, the Fed is pushing up prices not reflected in the CPI. Through its zero-interest-rate policy and direct asset purchases via quantitative easing, the Fed has lowered the cost of capital and raised prices for stocks, bonds, and real estate. In doing so, it has argued that rising asset prices create a "wealth effect" and are thus a key goal of its monetary policy.
Over the past five years, the prices of these financial assets have risen dramatically. However, unlike past periods of bull asset markets, these increases have not been accompanied by robust economic growth. To the contrary, the last five years have seen the slowest non-recession economic growth since the Great Depression.
This Fed-driven dynamic explains the rich-get-richer economy we've seen since the alleged recovery of 2009 began. The wealth effect has allowed the elites to push up prices for high-end consumer goods such as luxury real estate, fine art, wine, and collectible cars. But that is cold comfort to rank-and-file Americans struggling to find work in an otherwise stagnant economy.
Broader consumer price inflation has been kept at bay because many of the newly printed dollars don't even hit our economy. Instead, foreign countries purchase them in an attempt to keep their own currencies from appreciating against the dollar. In the current environment, a weak currency is widely (and wrongly) seen as essential to economic growth. That's because a weak currency lowers the relative price of a particular country's manufactured goods on overseas markets. Nations hope those lower prices will lead to greater exports and more domestic jobs.
Thus we see "currency wars," in which the victors are those who most successfully debase their currencies. That policy perpetuates greater global imbalances (between those nations that borrow and those nations that lend) and the accumulation of dollar-based assets in the accounts of foreign central banks.
The more debt the U.S. government issues, the more purchases these foreign banks must make to keep their currencies from becoming more valuable relative to ours. It is no coincidence that many of the countries heavily buying U.S. dollars, such as China, the Philippines, and Indonesia, are experiencing high levels of domestic inflation. Inflation may now be America's leading export.
In recent years, U.S. federal deficits have declined from more than $1.2 trillion to less than $600 billion. This is not because the government has made hard choices to raise revenue or cut spending but because rising asset prices have resulted in greater tax receipts from the wealthy. Yet this windfall can only last until the next meaningful correction in asset prices. If tax revenues fall, growing federal deficits would compel the Fed to print the difference. In that case, foreign banks would need to buy even more dollars to maintain their currency valuations. If they lose the will to keep pace, the dollar would lose relative value. A weaker dollar could be the spark that finally ignites significant CPI inflation in the United States.
As foreign currencies gain strength, consumers in those countries will gain buying power and more finished products will gravitate toward foreign shelves. Given that a significant portion of the products we now buy are imported, the diminished domestic supply could push up prices for common products like apparel, electronics, and appliances.
Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.
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Whatever Happened to Inflation?
It's hiding in the depths of the ocean.
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We've got to find it. Deflation makes the masses better off, and we cannot have that.
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Not necessarily. In a cash based economy yes. In a debt based economy like ours it means you can't service the debt and are foreclosed on.
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Short term pain long term gain.
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Deflation is a disaster for everyone. The masses would not do better with deflation.
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They would and they did for much of American history.
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Money deflation, yes, price deflation, no.
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Lol wut?
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$5 a lb for ground chuck, $7.50 a 6 pack of Bud. $8 a lb bacon. The 8oz blocks of Kraft Cracker Barrel Cheese that used to be 10 ozs 2 years ago are now 7 ozs and the price keeps rising...
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The rise in food prices has more to do with rising incomes in developing economies than monetary policy.
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It also has a lot to do with the California drought. And to some extent the ethanol mandate.
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The increase in the cost of the basic foodstuffs is probably negligible. The increased costs in the grocery store are the result of trying to keep corporate profits up.
I doubt the ingredients of a half gallon of ice cream went up by 33% in the time the half gallon container went to 3 pints so the price could stay the same.
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I'm going to assume the above is sarcasm.
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Actually it's sort of correct.
It's more that businesses tend to eat the increased input costs at first until they just can't take it anymore and then it ratchets up in fairly large increments. At least I see this happening a lot when it comes to foodstuffs and restaurants.
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MarkinLA|11.30.14 @ 3:20PM|#
"The increase in the cost of the basic foodstuffs is probably negligible. The increased costs in the grocery store are the result of trying to keep corporate profits up."You just argued both sides of the issue.
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I have to come back to this later. I am part way through the monetarist's list of parlour tricks the Fed can use to 'control' inflation. 1. Borrow what? The money the USG doesn't have? 2& 3 are just shuffling money to the future 4. IOR is a large part of why we're in this mess. IOR is violently deflationary you can pinpoint the DAY in October 2008 when it was implemented because that's when stock markets go into a tailspin. All that money is being stored up, so again it's just inflation deferred.
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Question: what happened in Japan? Massive monetary expansion and subdued prices for decades. I know their massive savings makes them non-comparable to America but it still needs to answered.
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Decades of stagnation have happened in Japan, right?
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Yes, but why no price increases?
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Price increases keep getting caught and tentacle raped before they can get very far. This IS Japan, after all.
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Because they save rather than spend their money.
Inflation only causes price inflation when the new money actually enters the every day economy. If it stays restricted to finance and investment markets then as far as the broader economy is concerned the inflation doesn't exist
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It likes to boomerang back at them.
Look up the "reversal of the yen carry trade".
It's complicated, but now they are actually seeing some real inflation, just not in wages.
Also, they have reentered recession (again). The preceding quarters of GDP growth seemed to have been fueled largely in anticipation in a new sales tax which caused businesses and people to "preload" as much of whatever they thought they would use in the future to avoid the coming tax. Once the tax took effect earlier this year they had negative 7% GDP growth, and then again last quarter they had negative growth meaning they are technically back in recession.
They're at the end of their rope with a 250%+ debt to GDP ratio as well.
Even with their recent currency devaluation, and devaluing faster than their neighbors their exports are still down as well.
I could go on and on, but short answer is they're screwed.
What likely will happen is massive currency devaluation to deal with the debt in real terms. (after decades of deflation)
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While clearly, the government has been cooking the books on the inflation numbers, I do think globalization has put some downward pressure on consumer prices partially offsetting the consequences of excessive currency expansion. That said, those same globalizing forces tend to make asset prices more sensitive to dovish monetary policy. That is to say, globalization has substituted asset price inflation for consumer price inflation to some extent. That's why at least the last two cycles have produced asset bubbles that burst with catastrophic consequences. Of course, that phenomenon has almost certainly contributed to the wealth inequality the Keynesians bemoan incessantly.
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I can't read 5 pages unless there is a plot.
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Oh, there IS a plot.
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I see what you did there.
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Don't know if it worsens the plot, but you can add /singlepage to the end of the URL:
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Thank you. I learned something today. Now I can drink.
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First, please edit the article to indicate authors under the sub-titles. It's impossible to know who is writing what until the end.
What isn't mentioned in any of the articles is the fact that excess fiat currency is *primarily* being loaned to "low-risk" borrowers, like major corporations, who do massive stock buy-backs on borrowed money, converting profits into capital gains ... to the benefit of their investors through lower capital gains income tax rates. I've read that corporate debt is now higher than at any time in U.S. history.
Even a tiny increase in the corporate interest rates will create a cascade that the FED won't be able to stop: runaway consumer inflation.
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And thus impossible to know when the first author begins.
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I'm still under the impression that at some point in the future, some massive political power (like China) is going to finally say "Enough is enough". At that point, the U.S. economy will collapse in on itself because of skyrocketing inflation. The FedGov will be happy, because it can pay off its debt more easily, and the rest of us will get fucked in the ass with our worthless dollar bills.
It'll officially be riot and loot time. Kinda looking forward to it.
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Hedge with Bitcoin.
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Hedge with guns and ammo and be ready to use them.
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All I know is my paycheck doesn't go nearly as far as it did before QE began.
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Did you know you could save 15% on your car insurance by switching to Geico?
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Go home, Napolitano. You're drunk.
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"Libertarian, my dear, you are ugly, and what's more, you are disgustingly ugly. But tomorrow I shall be sober and you will still be disgustingly ugly."
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shame on you for complaining commie! the koch bros think you have too much money already! you should take a 50% pay cut as pennance and for the good of capitalism!1!
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Isn't it a bit early to start boozing on a Sunday?
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It's never too early to start boozing.
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True.
*takes a swig of gin and ginger ale*
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"In recent years, U.S. federal deficits have declined from more than $1.2 trillion to less than $600 billion. "
Austerity!!!!
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Just never ask Peter Schiff anything ever again.
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How dare he be mostly right!
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As I told the Peanut Gallery back in 2009 you can't have inflation with so much excess capacity in the system. Goldbugs are not rational beings though.
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I used to measure inflation by how much money I had left after paying for the necessities. That was before QE began. Now I don't have any money left over. Haven't for a while. So by my measure, there has most definitely been some inflation going on. Granted my measure is not scientific, but as they say, figures don't lie but liars figure. As far as I'm concerned, the people who measure inflation are doing a lot of figuring.
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Palin's Derplug:
More like increasing the monetary base when hardly any of it actually left the fed isn't going to cause inflation.
It just gives the banks time to repair their balance sheets. It was all just another bailout.
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More like increasing the monetary base when hardly any of it actually left the fed isn't going to cause inflation.
This. The inflation hawks were wrong in their assumption that those dollars would find their way into the market through the customary mechanisms, but not about what would happen if they did.
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can't have inflation with so much excess capacity in the system.
Except there's a clear positive correlation between unemployment and inflation, so you're but what's new.
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Legit question: What is wrong with the market monetarists' point that inflation won't get out of control since banks are being paid that .25% interest to hold on to government reserves?
Not sure if that's unsustainable deferred inflation or what, since the interest is awfully low, and I imagine it encourages banks to consistently hold onto at least SOME cash reserves. Why is inflation then a foregone conclusion (like more than is natural when an economy is going full steam)? -
That's pretty much why there hasn't been a lot of inflation.
The whole thing was just another way to bailout the banks and give them time to repair their balance sheets. Increasing the monetary base isn't going to cause inflation if it's just sitting in accounts at the fed.
And actually deflation can happen even when an economy is going "full steam". Productivity gains... Problem is CBs always paper over both kinds of deflation, good or bad.
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Bail out CT. The Fed bought US Treasuries with QE funds.
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There is no magic. Very few ways to explain in this supposed current dollar-inflating environment the slow increase in nominal dollar cost of some general consumption basket. Productivity maybe the single most important reason, but I'd guess not more than half.
Concurrently is the inflation of the money supplies of many international currencies, diluting dollar "inflation” worldwide by spreading it wide and thin. Competitive debasement, obvious to the rest of the world. Foreign (central bank) holdings (in custodial accounts at the US T Dept) is amazing, a major forced savings of developing countries households. Winner: US taxpayer doesn't have to pay for all of it's gov’t's promised spending - inflation tax to the rest of the world. Ha-Ha! This is the most insidious factor and one that the lewinsky press suckups would avoid exposing, but they're too stupid to understand. The Brazilians and Russians correctly whine, but there is a big first-mover's problem to break the cycle of relying on US dollars as wealth storage and exchange medium. In other words, the US political class is milking the reserve status of the dollar.
Another complicated possibility: less real dollar pumping due to accounting hocus pocus. "Private" banks hold excess reserves for interest payments, “recapitalizing" them via currency inflation tax. Credit expansion constrained, gov't spending takes up slack. Net pressure on general prices lower than indicated by official Fed monetary expansion.
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If US treasury rates exceed the IOR rate, then money will come pouring out of the banks fed vaults into the real economy and that will light inflation on fire.
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Lack of comments on this thread is disappointing.
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Foreign goods coming in to the country mask domestically produced goods inflation.
If a locally made door is going up at 10% a year, but a Chinese made door is staying the same, and is 1/4 the price, most of the doors sold will be Chinese - with no inflation.
But, the local goods because of inflation are getting priced out of the market.
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Assets have really gone up in price, too. Which makes me happy.
The cash has to filter down through the various levels of the economy to really produce inflation, and so far that hasn't happened. It won't for awhile either based on how the money is loaded into the economy through the big banks.
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If the world moves off the US dollar as the standard currency for trade, then you'll see massive inflation. All the dollars will start being sold off by foreign countries and all corporations. They will return home. The dollar will plummet and anything foreign produced will skyrocket in price. It will make US made goods cheaper, but since we in North America have moved away from producing things this won't help as much as it could.
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That last point isn't true. America still has a large manufacturing base in addition to the burgeoning oil and gas sector. Everything else is true.
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I know....it is more white lab coat manufacturing than factory work now. But, there was a time when a person could start a factory in their garage and start building things. Not so much now. There are impediments to entry everywhere.
If the dollars all returned home, there could be a giant manufacturing boom. But, our thinking isn't manufacturing and meeting demand, in that way.
That could change quick enough, too.
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I really loved this article. Let's have more of this "post-mortem" analysis, please. I hope the trend spreads to nightly weather forecasters and climate alarmists. Seriously, we need to calibrate Chicken Little.
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"Market signals aren't perfect, but they're much better than the predictions of academic economists or government bureaucrats." Sumner for the win!
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Hittem up JD, I say hittem up!
www.Anon-Rocks.tk -
(yawn) If the new money is sitting in the Fed then is does not affect the Law and Supply and Demand. And, as everyone knows (except Austrian, the price of money is determined just like the price of everything else -- Supply and Demand.
Friedman proved this decades ago, but he's not a crazy gold nut, so he gets ignored. Even though Hayek eventually accepted Friedman's view. (Shh, don't tell anyone).
Likewise, if Ford creates a surplus of a million new cars, but keeps THAT supply off the market, then it will have no effect on prices. duh. The scaredy-pants inflation is STILL not inevitable ... but only if the Fed pulls back the excess money when demand for it picks up.
Unless and until the Law of Supply and Demand is repealed, all these excuses are more evidence that Austrians are just another cult.
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the price of money is determined just like the price of everything else -- Supply and Demand.
It's actually not determined by supply and demand when you have a central bank with a legal currency monopoly and conflicting mandates regarding its purpose. It's often determined by other factors, including very often political factors. Precisely that lack of real price signals and the corresponding market disruption of central planning is kind of the crux of the issue. Central banks aren't immune to the calculation problem that plagues all central planners. What you're describing is the state of money in a free banking system, which ironically enough, you oppose and Austrians (even the strawman ones that haunt your delusions) support.
Even at the level of simple platitudes in which you operate (and beyond which you are incapable of thinking), your position runs into just a wee bit of a self-contradiction in that your money supply in its present state of perfect supply-demand equilibrium includes trillions of dollars of reserves parked at the fed instead of, you know, being utilized in the market which is ostensibly clamoring with demand for it. If that money had any velocity inflation would be rampant. Curious economists of all schools, including Keynesians and monetarists, have an interest in explaining why that (so far) hasn't happened. When they condense it to bumper sticker form we'll be sure to wake you up.
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Austrians were wrong. Own it.
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Guess the whole predicting the 08 crash didn't count, right?
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In the abstract, the new fiat currency isn't "in circulation".
The FED wasn't pumping money into banks, but rather propping up the value of U.S. Treasury Bonds, as well as Fannie/Freddie equity. The funny money was forcing low rates on T-Bills and bailing out all the bad loans held by mortgage investment companies. It was intentionally "boxed off" against the consumer economy.At the same time, the FED and Dodd-Frank induced banks to sideline assets and constrain their lending. Only the best risks got loans and the advantage went to large corporations, who borrowed billions at low rates and engaged in massive stock buy-back operations. The result was to convert dividends to capital gains, at a lower tax rate for investors. So, the most obvious "economic indicators" were booming, while the consumer economy languished.
As a consequence, the level of corporate debt jumped to nearly $10 TRILLION, an historic record:
http://www.nasdaq.com/article/.....n-cm366891So, it's no wonder that consumer inflation hasn't (yet) occurred, in spite of extreme monetary inflation.
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And no mention of credit tightening in the whole article? Credit supply dwarfs the money supply. When credit is tightened as it was post 2008, there was no way inflation was happening.
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Really nice post, this is really helpful for understanding monetary policy.
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Nice post, this post really have lots of information about monetary policy and the differences in the past few years of financial assets.
