Monday, April 13, 2009

Testing Theories Of Inflation

Right now we have a situation with high money supply growth in America and most other countries. According to Monetarist (and in most circumstances also Austrian) theory, this should lead to higher price inflation.

Yet we also have a situation with high unemployment and low capacity utilization in America and most other countries, something which according to Keynesian theory should lead to deflation (or at least disinflation).

This leads former Fed governor Laurence Meyer to talk of how the near future development of price inflation will provide a test of theories of inflation, as the two theories have opposite prediction of how it will develop.

Such tests have however already been performed. As I pointed out yesterday, Zimbabwe has had extremely high money supply growth rate while also having extremely high unemployment (60 to 80%) and extremely low capacity utilization (20%). The result was an inflation rate of 231,000,000%.


Blogger Reginald said...

A lot of economists (e.g. US Fed) are relying on capacity utilization as a predictor of price inflation. I think it merits the effort to explore this theory even further. As I see it, high capacity utilization only occurs if companies can take advantage of a debased local currency in terms of exports. In gist, a higher utilization may occur *after* massive price inflation. For example, a Zimbabwean company can easily cut the prices of its exports because its domestic costs are steadily shrinking.

7:31 PM  
Blogger novid said...

So the dollar has yet to fall apart, probably because everybody else is doing so poorly. The question is Stefan, what is going to be the catalyst that causes the dollar to fall and commodity prices to sky rocket?

It looked like it was beginning with the Feds actions to start buying $300B in treasuries but that did not follow through.

Is it just going to take time? More and more economic data being published so that eventually people realize there are real consequences to all of this quantitative easing?

The argument against inflation is that so much wealth has been destroyed that re inflating is just trying to get us back to status quo but that makes no sense to me considering it was all fake money that shouldn't have been there in the first place caused by Greenspan's cheap money.

9:18 PM  
Blogger Mr. Peabody said...

Inflation will not start untill the dollar starts droping significantly in value. When that happens watch out, inflation will start to rise at a fast and furious pace.

10:14 PM  
Blogger Wille said...

Didn't this already get tested in the 70'ies?
Keynesians seem to be in the habit of omitting/forgetting any proof against their theories.

The definition of stupidity is doing the same thing over and over again, expecting different results - the printing press has always rendered the same results, so why are they expecting a different result this time?

1:11 PM  
Blogger Marcf said...


the 70s had a entrenched inflation due to wage-price spiral. This time around the wage-price spiral did not in fact take hold last year amid the oil shock (speculative) and we are now facing deflation. Do not be too quick to throw out Keynesian theories when it comes to stabilizing prices either by demand of goods or supply of money.

Stefan, why do you position the two views as opposite and imply that the score will soon be settled by observation. If one thinks of the monetary mass and views economic slowdown and credit contraction as removing liquidity and the FED QE as adding liquidity the effects are in fact opposite but 'fungible', the question is are the FED doing enough fiscally and monetarily to counter-act the delevaraging going on, the two are going on at the same time.
The hope from Bernanke et al is that in fact we achieve price stability, which would be a happy outcome, even at the price of stagnation. Whether we undershoot or overshoot will not change the fact that QE has a positive contribution to monetary led inflation and that, conversely credit contraction, has a deflationary contribution to prices. IN other words, we are not 'testing' anything but whether the stimulus in the US are *enough* to balance monetary mass.

6:08 PM  
Blogger Reginald said...


"If one thinks of the monetary mass and views economic slowdown and credit contraction as removing liquidity..."

That statement is just wrong. The money created when a loan is issued does not vanish upon default, or de-leveraging. The creation of money temporarily slowed, but the Fed's doubling of the money supply has taken up any slack. There is a lagging time factor in prices, but retail food prices are stable. In contrast, during the Great Depression when banks failed money did vanish (e.g. check deposits w/o FDIC) and retail food prices did decrease substantially. This is a recipe for stagflation.

9:53 PM  
Blogger stefankarlsson said...

Marcf: You have completely misunderstood the concept of deleveraging. Deleveraging is in this context about reducing the ratio between money supply and the monetary base. It's in other words a factor in determining money supply and not a factor in determining the effects of money supply on prices.

10:03 PM  
Blogger Wille said...

the 70s had a entrenched inflation due to wage-price spiral.The "wage-price spiral" is circular logic at its best: "prices go up because wages go up so prices go up".

You don't see a flaw in there somewhere, that there might be another cause somewhere to be found?

10:51 PM  
Blogger Ke said...

Stefan, what's preventing us from having a decade-long deflationary crisis like the 90's Japan?

Reginald, you wrote...

"Depression when banks failed money did vanish (e.g. check deposits w/o FDIC) and retail food prices did decrease substantially. This is a recipe for stagflation."

That sounds like deflation to me. Am I drinking too much kool-aid from Mish?

6:36 PM  
Blogger Reginald said...


"That sounds like deflation to me. Am I drinking too much kool-aid from Mish?"

Mish views a slower rate of growth in the money supply as equal to the destruction of the money supply. That's just wrong. Loans are still being made and money is being printed, but at a slower rate. It's called monetary disinflation, not monetary deflation.

To avoid confusion, I say monetary in/deflation and price in/deflation. The former eventually results in the latter.

As I see it, price inflation will first occur in food and is already occurring. As wages and assets decrease, food prices are stable. That's really a rise in the cost of food.

9:23 PM  
Blogger kanej2 said...

Stefan & et al,

I maybe out of my league here, but
isn't it possible that price inflation has not taken place yet because the "new money" has not left the banks, i.e. it is not being "utilized"? Once the "new money" is in the hands of consumers, only then will we experience what we all fear. What do you guys think? Is there any statistics to find out if the banks have lent the new money?

6:39 PM  

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