Defending inflation

A golden coin stamped with a rather wizardly-looking figure.
Coin of Kanishka, ca. 130, Pakistan

It looks like inflation has re-entered ~the pop­u­lar eco­nomic dis­course~ and will remain there for a while. It both­ers me that the term is so often used in a vague, scold­ing way, with the inten­tion of (it seems to me) stopping conversations — investigations — rather than sharp­en­ing them. So, I wanted to share some tools for think­ing about infla­tion that I’ve found useful: not as a pundit, econo­mist, or investor — I am none of those things — but sim­ply a curi­ous, crit­i­cal citizen.

The infla­tion defender has LOGGED ON.

(Parts of this newslet­ter are drawn from a pre­vi­ous post on the same subject, but most of it is new.)

What inflation isn’t

The apho­ris­tic econ 101 def­i­n­i­tion of infla­tion is “too many dol­lars chas­ing too few goods”, which is actu­ally pretty useful.

Inflation scolds tend to focus exclu­sively on the first part of that formulation, “too many dollars”. Some will tell you that an increase in the num­ber of dollars cir­cu­lat­ing is infla­tion, full stop. This fac­tion is reflex­ively crit­i­cal of new dol­lars, espe­cially the kind “printed” (electronically) by cen­tral banks, which they see as unfairly, even ruinously, dilut­ing the value of all existing dol­lars.

And honestly, there’s some­thing seduc­tive about their breezy assertion: “If you print more dol­lars, each one is worth less.” I mean … it sounds axiomatic, doesn’t it?

But, give it two sec­onds of thought, and you’ll real­ize it’s not true, because it pre­sumes a kind of auction-house uni­verse that doesn’t actu­ally exist. The real economy isn’t a crowd of con­sumers with fist­fuls of cash bid­ding up the price of a fixed num­ber of goods on display. It’s much more dynamic than that: a dance between demand and sup­ply, in which the pres­ence of new dol­lars becomes pow­er­ful incen­tive to pro­duce new goods. That dance is complex, and it changes depend­ing on all sorts of factors, many of them non-eco­nomic. Think pol­i­tics; think weather; think, even, of etiquette. In many contexts, it is sim­ply not cool to sud­denly raise your prices. Can such a flimsy social con­tract really have any power in the cold-blooded econ­omy? It can. It does!

The key, I believe, is to under­stand infla­tion not as an abstract axiom but a phys­i­cal process that unfolds unevenly in time and space. Maybe that’s why I appreciate “too many dol­lars chasing too few goods”; the verb “chas­ing” almost forces you to imag­ine a dynamic activ­ity (with per­haps a bit of Wile E. Coy­ote in it?) rather than a fixed relationship.

So, yeah, I’m not sure I can improve on the apho­ris­tic def­i­n­i­tion, other than to insist that both parts are crucial: “too few goods” as much as “too many dol­lars”.

And what’s the result of this process? I would say you’ve expe­ri­enced infla­tion when the same num­ber of dol­lars gets you fewer of the things you want from the real world. This sounds uni­formly bad, but, as we’ll dis­cover, it’s not.

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A specter is haunting the op-ed page

A neat def­i­n­i­tion isn’t enough, though, because in the pop­u­lar eco­nomic dis­course of the United States, “infla­tion” oper­ates less as a tech­ni­cal term and more as a dark word of power, intended to con­jure a particular period in Amer­i­can his­tory; indeed, a particular view of that par­tic­u­lar period.

I mean, you know this: an infla­tion scold can­not fin­ish a sen­tence with­out invok­ing the specter of the 1970s, rais­ing the revenant of the “bad old days” before Reagan. It’s not real eco­nomic his­tory they are offering; rather, a kind of scary “cultural memory” groomed into a pow­er­ful rhetoric tool.

It’s a ghost story, truly.

Of course, there really was high infla­tion in the 1970s! But it wasn’t driven only, or even primarily, by government spend­ing; there were also severe “sup­ply shocks” caused by oil pro­duc­tion pol­i­tics and a poor global grain harvest. There’s your “too few goods”. The “too many dol­lars” came into play as the U.S. gov­ern­ment bor­rowed money into existence, only to dis­cover it couldn’t change the under­ly­ing real­ity of those short­ages.

(There was another impor­tant factor, the end of the wage and price con­trols insti­tuted by the Economic Sta­bi­liza­tion Act of 1970, but, candidly, I don’t under­stand the details, so I’m not going to like, read the Wikipedia page and pre­tend I’m an expert.)

Let’s exor­cise this ghost at last. In the 1970s, the sup­plies of two foun­da­tional goods, oil and grain, were ter­ri­bly con­strained — not by eco­nomics, but by pol­i­tics and weather, respectively. Too few barrels, too few bushels. Yet, somehow, through the caresses of selec­tive memory, it’s the demand side, the money chas­ing those bar­rels and bushels, that has become the bogeyman.

(For curi­ous nerds, this analysis of that period by Alan Blinder in 1982 is very good, and this paper from 1978 dis­sects the food sup­ply prob­lems in detail. This more recent review from the Fed­eral Reserve is also useful.)

Let me now remind you that the 1970s were fifty years ago. The global econ­omy has been utterly remade in the time since. Fifty years ago, there wasn’t any internet; busi­nesses didn’t even use fax machines. Fifty years ago, China’s pro­duc­tive capac­ity hadn’t come online; Mao was still alive!

I guess what I mean to say is, when you encounter some­one who, rather than engag­ing curi­ously and cre­atively with the par­tic­u­larities of the present, anchors their warning about infla­tion in the 1970s — “we don’t want to go back to THAT, do we?”—you should take that as a warn­ing: a sign that they are, some­what literally, try­ing to cast a spell on you.

A physical process

For ten years, no matter what central banks have done, no mat­ter how much money they’ve printed — and they have printed a lot — inflation hasn’t left its steady orbit around 2%, the tar­get these insti­tu­tions osten­si­bly struggle to maintain. For ten years now, there has been no strug­gle. This really stresses cen­tral bankers out. Why is infla­tion so low??

My per­sonal (crackpot?) the­ory is that the answer has to do with (a) the dig­i­ti­za­tion of more goods and ser­vices — demand for Netflix can’t sud­denly out­strip supply, because Net­flix can repro­duce its ser­vice instantly and infinitely — along with (b) the “perfection” of phys­i­cal sup­ply chains.

In late 2019, the real econ­omy could, in a way unimag­in­able in the 1970s, spin up addi­tional pro­duc­tion of many goods very quickly. This was espe­cially true of electronics, which con­sti­tute so much of the world’s con­sump­tion these days. You want twenty mil­lion flat-screen TVs? They’re already on a boat!

But it’s not 2019; we live in a dif­fer­ent world now, and the pan­demic has dis­rupted those “perfect” supply chains. The pro­duc­tion of lumber is a well-pub­licized example; as I’m writ­ing this, sawmills don’t have the capac­ity to keep up with surg­ing demand. It takes a while to build new mills and, in the meantime, the lumber that is avail­able is being sold at shock­ingly high prices. This is, to be clear, an exam­ple of real infla­tion! (If you’d like to learn more about these lumber sup­ply woes, this deep explainer is exquisitely detailed.)

(An update, sev­eral months later: the price of lum­ber fell as rapidly as it had risen.)

There are plenty of other exam­ples, chronic and acute. Bay Area hous­ing has suffered from run­away inflation for decades, the result of polit­i­cally con­strained sup­ply. The lat­est gen­er­a­tion of snazzy GPU cards has suf­fered from both rationing and (resale price) infla­tion, because their pro­duc­tion hasn’t kept up with demand that has been mul­ti­plied by a cryp­tocur­rency boom. (Snazzy GPUs can be used to play video games; they can also, unfortunately, be used to mine Ethereum.)

But these specific exam­ples in spe­cific mar­kets only rein­force the point: infla­tion is a phys­i­cal process that unfolds unevenly in time and space.

So I don’t mean to sug­gest that cit­i­zens of the United States ought never to be wor­ried about infla­tion; all three short­ages men­tioned above are caus­ing real prob­lems, real pain. (Well, two out of three. The GPU short­age might just be an annoyance.) Rather, I think those wor­ries ought to be focused on clogs in phys­i­cal pro­duc­tion and distribution, not merely the cir­cu­la­tion of new dol­lars.

Because I am strongly in favor of the cir­cu­la­tion of new dol­lars.

A silver coin stamped with a stern-looking helmeted warrior-king.
Tetradrachm of Seleucus I, ca. 304-294 B.C., Iran

Pick a side

Here’s where things get some­what sharper.

As you think about and dis­cuss infla­tion, and how much of it is tol­er­a­ble and/or desirable, I encourage you to cul­ti­vate a bit of “class consciousness”.

A per­son with, say, a mil­lion dol­lars in the bank, plain liq­uid cash, might rea­son­ably be con­cerned about dol­lar infla­tion, even a modest amount.

But I am, uh, not such a per­son, and I don’t really care about their con­cerns. I don’t think you should, either! One strange fea­ture of the pop­u­lar eco­nomic dis­course is that the rar­i­fied trou­bles of the very rich often get dis­cussed as if they were “normal”, but: they are extremely not normal.

The mil­lion-dol­lars-in-cash-havers can fend for themselves.

Going further: if you are a per­son with a mortgage or a stu­dent loan, when it comes to inflation, your inter­ests are directly at odds with Mr. Monop­oly up there. Mod­est inflation is good news for you, because your debt is counted out in dol­lars, and it would be nice to pay it back in dol­lars worth less than the ones you were loaned. (The polit­i­cal econo­mist Mark Blyth has pointed out that the high infla­tion of the 1970s was, in this respect, a gift to Amer­i­cans with mort­gages at that time: a dis­count on the price of their homes.)

If you have more debt than assets, infla­tion is like the wind fill­ing your sails: it pushes in the right direction. There are a lot of peo­ple in the United States for whom that first state­ment is true, and it’s like … folks, show a lit­tle self-interest!

Finally, if you live paycheck to pay­check — part of a class whose con­cerns I care about much more than I do the mil­lion-dol­lars-in-cash-havers — modest inflation is basi­cally neutral. Prices go up slowly over time, but so do wages. (This process is, again, uneven in time and space, and I acknowledge that wage inflation can lag behind price inflation, which is not good. A tight labor mar­ket helps in this regard; work­ers can be more selec­tive, insist on higher wages. For more on this, see the addendum.) Over time, you pay inflated prices with dol­lars equally inflated, and the urgent eco­nomic ques­tions of your life don’t have much to do with infla­tion at all.

The underrated specter

For the past twenty years or so, econo­mists have wor­ried about defla­tion as much as infla­tion. It’s not part of the pop­u­lar eco­nomic dis­course in the United States, though, so many Amer­i­cans can’t describe it — or even imag­ine it, really. Here’s a quick scenario.

First: I want to buy a ham­mock. It is summertime.

Second: overnight, some cryp­to­coin with a fixed sup­ply becomes the offi­cial cur­rency of the United States. The infla­tion scolds cheer; at last, “hard money” reigns supreme!

Suddenly, every trans­ac­tion in the econ­omy requires the use of this cryptocoin. Strong and grow­ing demand bids up its value steadily, and it becomes clear to me that, rather than buy a hammock today, I can wait a month, allow defla­tion to work its magic, then buy a luxury hammock with the same num­ber of cryp­to­coins. Another month and I can buy a lux­ury ham­mock and an auto­matic banana peeler!

Seems pretty sweet for me … but what about the hammock factory? Sales plummet. What’s the deal? It’s hammock season! Ah, but Sloan and the other hammock-wanters are all out there waiting, waiting … and by the time we deign to part with a few of our pre­cious cryp­to­coins, the ham­mock fac­tory has gone out of business, sent all its weavers home.

I am rich with defla­tionary cur­rency in a hollowed-out, ham­mock-free econ­omy.

This isn’t just a cute story: it really happens. It has been a deep and recur­ring prob­lem for Japan over the past twenty years. In 2016, the gov­er­nor of the Bank of Japan defined “defla­tion” as

a sit­u­a­tion in which prices of a broad bas­ket of goods and ser­vices declines in a con­sis­tent manner, thereby causing all con­sumer prices to con­tin­u­ally fall. When look­ing at the over­all economy, defla­tion causes a decrease in sales, and there­fore profits, which spurs employee lay­offs and/or wage decreases. Con­sumers then hold back on spend­ing as the future looms with uncertainty. Subsequently, com­pe­ti­tion between firms becomes fiercer, caus­ing price races to the bottom. Defla­tion is thus self-perpetuating: the economy falls into a “bad equilibrium, in which eco­nomic activ­ity is shrinking.” This has been the state of Japan’s econ­omy for 15 years [ … ]

This is a really, really bad sit­u­a­tion; it deserves as much worry and con­ster­na­tion in the pub­lic imag­i­na­tion as run­away infla­tion.

Modest infla­tion is a good thing for an econ­omy. It encour­ages peo­ple to spend their money today, not next month. Any­one who pro­duces or sells any­thing ought to be root­ing for it.

In other words: where are my defla­tion scolds??

To summarize

The infla­tion defender has LOGGED OFF.


Many of the replies I received from sub­scribers poked at this idea of wages and prices slowly ris­ing together, basi­cally ask­ing some form of the question: do they really? Because, of course, if they don’t, more-than-modest infla­tion becomes a big­ger prob­lem for the per­son liv­ing paycheck to pay­check.

This is a very fair question, informed by the real­ity of gen­eral wage stag­na­tion in the U.S. over the past twenty years.

Here’s a view from the Atlanta Fed. I chose this one so we could focus on the first and sec­ond quartiles, the work­ers earn­ing the lowest wages:

A graph showing wage growth since the late 1990s, oscillating around 2-3%.
Wage Growth Tracker, Federal Reserve Bank of Atlanta

If you com­pared a graph of price inflation over the same time period, you would see it hov­er­ing in roughly the same range. (The excep­tion is 2008-2009, when inflation spiked to about 5%, then dipped below zero before return­ing to the 2-3% zone.) So, wages have been grow­ing, slowly, in dol­lar terms; it’s just that they’ve been bal­anced by infla­tion, leav­ing their real value basi­cally flat. For decades!

(If you’re interested, I recommend exploring the other view options; it’s a really rich, useful visualization.)

The thing to consider, I think, is that usually, the “too many dol­lars” con­tribut­ing to infla­tion — stimulus checks, infrastruc­ture projects, unem­ploy­ment insur­ance payments, loans to busi­nesses, etc.—are also tight­en­ing the labor mar­ket, which allows work­ers to be more selec­tive and demand higher wages … 

 … which is, I acknowledge, a lit­tle bit hard to imag­ine against the back­drop of the past twenty years. It is rea­son­able for an Amer­i­can to feel skep­ti­cal that wage nego­ta­tion even like, happens. But it does! There’s evi­dence it’s hap­pen­ing right now; it will be inter­est­ing to see how wages look in a year.

It’s worth say­ing again that the process is uneven in space and time. I think, for exam­ple, of the min­i­mum wage increase recently voted into law in Florida, which will take it to $15 gradually. That rep­re­sents a mean­ing­ful increase for a lot of peo­ple whose wages have been lag­ging for decades. It will show up on the Atlanta Fed’s graph, above, as a shal­low rise over the next six years, the Florida $15 diluted in the national num­bers; it will look smooth, gradual, continuous; but of course, it will have been the result of a dis­tinct event in space and time, a kind of state-level “negotiation” long overdue.

None of this is meant to wave away the question; if you’re going to keep any con­cern front and center, this is the one. Talk about “cultural memory”, though; I think the United States has maybe never known (?) what a truly tight labor mar­ket looks and feels like. The appeal of “full employment” isn’t only, or even mainly, that everyone has a job; it’s that every­one has the power to turn down a job.

Was anything about this discussion confusing? I am striving for a tone that is not “economics know-it-all” (which I’m not) but like … “engaged co-investigator”, though I don’t know if I quite achieved it. I’m curious to know if you found this dispatch clarifying, muddling, meh, or anything in between.

And if you have any specific follow-up questions, I will do my best to answer them!

Whatever you choose, Robin will see that this response is coming from . Please also sign it with your preferred name âśŚď¸Ź

A silver coin roughly stamped with a tree and the word MASATHVSETS.
Sixpence, ca. 1667–1682, John Hull

May 2021