Fear of inflation again appears to be rising to a fever pitch. Yet confusion about it persists, both among the uninitiated and the cognoscenti. It calls for a quick review of the basics.
My students invariably state that inflation means the value of their money is going down. But of course, it is not what it means. Erosion of monetary value is a mere consequence. They will also sometimes claim that they can no longer afford Knicks tickets due to inflation. But this is also mistaken. Inflation is defined as an increase in the average price of goods – not in that of a particular commodity. It is true, however, that inflation causes a fall in the purchasing power of the domestic currency.
Some economics students also confuse the fall in the purchasing power of their currency with its depreciation. Yes, the two are interrelated, and often follow similar trends. But they are not the same. Depreciation refers to a fall in the value of one’s currency vis-à-vis other currencies. If the dollar, for example, can exchange for fewer and fewer yen, we say that it is depreciating relative to the yen. In practice, concepts like inflation, currency exchange rates, and purchasing power are often difficult to disentangle. They interconnect in a number of feedback cycles that it would be beyond today’s scope to explain.
But there is another distinct form of inflation that has hitherto seldom been called by that name. It matters because it contributes to so much of the present confusion. I refer to asset price inflation. Anyone puzzling over how the U.S. economy has managed to avoid inflation despite unprecedented monetary stimulus (and another fiscal boost waiting on deck) would do well to keep the distinction in mind.
The reckless abandon with which the Fed and U.S. Treasury have pumping up the moribund U.S. economy would, in normal times, cause a rapid expansion with inflation an unavoidable consequence. The common analogy to recent government policy is the “flooring” of a car’s accelerator pedal. Yet over the past decade and a half or so, there appears to be some blockage in the economic transmission. The economy has consequently remained in the doldrums.
And herein lies the mystery. Asset price inflation appears somehow to be “standing in” for goods price inflation. Instead of boosting the economy, recent government attempts at stimulus have mostly enlarged bank accounts. In the past, inflation would have a mildly progressive redistributive effect, since the purchasing power erosion of the dollar disproportionately affected those with fat portfolios. But in the “new normal” of asset price inflation the opposite happens; it is the wealthy who gain.
What then are we to make of the fact that the investing class is again sounding the inflation alarm? I’ll be honest – there is no obvious explanation. I grant that it is not unreasonable to expect the sizable government stimulus, coupled with our expected (hoped?) emergence from the pandemic, to cause a notable expansion. But the Fed has had its foot on the pedal for more than ten years! And inflation remains nowhere to be seen. Is today really that different?
Unlikely. As I’ve noted, if there is a case for inflation at all, it will be a longer term structural phenomenon. As argued by Trevor Jackson, among others, deflation is a much greater concern. I know, a fall in average prices does not sound bad. But then look at the consequences: Postponed spending, plummeting profits, mass layoffs. Little wonder that the last time that the U.S. economy went through a deflation was during the Great Depression.
Yet the mother of all stimuluses that we are presently witnessing appears to be offering cold comfort. Inflation remains stubbornly low. Real interest rates here and abroad have been flirting with – and in a few cases entering – negative territory. This is something that pretty much never happens.
I therefore read recent alarm about inflation as “alarm” and possibly more than a kernel of wishful thinking. Say what? Well, for one thing, inflation would quite obviously signify that the more worrisome deflation peril has receded. And with the enormous killing the rich have made in the decades following the financial deregulation of the 1980s and 1990s, it would take considerable price inflation to appreciably erode their returns.
With deflation the alternative, it strikes me as a bit disingenuous to express “fear” of inflation. I would be much more concerned about the depression that would ensue when the Fed’s “car” runs out of gas.