People are being told by governments, central bankers, and leading mainstream economists that money-base expansion is not inflationary — because the money would remain in the portfolios of banks and would not spill over into the hands of firms and private households. This is, to put it mildly, an uninformed view. Let us start right from the beginning, FULL ARTICLE
Source link: http://blog.mises.org/10207/inflation-what-you-see-and-what-you-dont-see/
Inflation: What You See and What You Don’t See
Previous post: The Heroic Professor Nesson
Next post: In Comes the State
{ 25 comments }
The lag between changes in money and cpi seems to be about 4 years, although I’m sure it’s not constant and depends on the phase of the business cycle we’re in. But that corresponds fairly well to an distributed lag econometric analysis in an old text book that ended with data in the late 1980′s. In that analysis, the max effect happened 4.5 years after the change in money. I can’t believe the feds don’t understand that lag structure. That means that policies today will have their max effect in 2013, just in time for the next presidential election.
“max effect in 2013, just in time for the next presidential election. ”
I dunno fundamentalist… that might be in US, smaller economies like UK have shorter lags… BoE studies of a few years ago said 18-22 month lag from M1 to CPI… also averages are dangerous, as present bust could be an outlier… my bet is we’ll start to see fast CPI increases by first months of 2010…
Excellent and timely article.
I am presently struggling through an economics class as part of my MBA curriculum. To say the professor is a Keynesian is to put it mildly, but nonetheless the class is interesting.
For the life of me I can not figure out how people blindly accept the mainstream definition of inflation as the increase in prices…and, so long as “inflation” remains within a politically acceptable range of 2-3%, it is nothing to worry about. It’s like saying robbery is OK so long as the thief doesn’t take more than 3% of your possessions every year (government manipulation of inflation stats notwithstanding, of course).
I don’t see current price reductions as deflationary, however. I see price reductions as corrections; something the economy sorely needed after the massive bubble burst. Declining prices represent the market’s attempt to better allocate resources.
fundamentalist,
there is no doubting a significant lag occurs between money expansion and CPI but as we know CPI is both methodologically flawed and often outright misrepresented. i feel that the real effects of inflation appear to the average person long before CPI actually recognizes it. i’d be interested in knowing the “real” lag and not necessarily the lag the government data portrays.
agree with previous commenters about CPI being flawed-to-meaningless. MONEY IS FUNGIBLE. It can go into selected “consumer goods” or into stocks, treasuries, houses… it can move abroad (rememebr the carry trade?)… it is completely pointless to look only at potatoes and gasoline.. or any other arbitrary selection.
The fiscal pumping by the US Fed and bank bailouts has provided the illusion of making financially unsound banks appear to be financially sound. Such strategy misleads investors. Easy credit and state financial assistance made unsound high-tech firms appear to be financially sound and viable prior to the high-tech meltdown. Many investors were misled and many good companies folded as a result of state fiscal mischief. It is perhaps unfortunate that the same state fiscal policy will continue.
flix i agree and your post also illustrates why central planning will always fail. despite their best efforts at directing asset “re-inflation”, ultimately the market may direct resources to other areas of the economy (ie money expansion is a shotgun not rifle)
The level of information that is processed in seconds allows market participant assess the impact of money supply changes and they direct resources accordingly. This isn’t the market of our grandfathers.
If you want to know exactly where inflation is going to be in 6 months, just look to the bond market.
From where I sit, the increase in money supply is more a balance sheet entry and the credit is offset by a corresponding debit. And investors account for these entries in their decisions.
fundamentalist,
You don’t know if it is a four year lag or a two year lag or 18 months or 25.7 months and as a matter of fact it could be any or all of these depending on the period and economic events. We should step back to basics with Hayek.
Only the market can know enough to manage the economy.
Greg, you are making the same mistake. You are assuming knowledge that is simply impossible for anyone to have with any precision. Would you be able to tell me the money supply changes from yesterday to today? Of course you can’t. You would cite government statistics but their statistics are simply educated guesses at best.
Freedom and free markets are the solution and the only solution. Central planning requires hubris beyond reason.
If General Electric has a bad year, there will not be “long and variable lags” before GE’s stock price falls. The stock price will react to bad news immediately, or else arbitragers would cash in by shorting GE. It is the same with money. If the fed is really doing something inflationary now, then the value of the dollar must fall now, or else arbitragers would cash in by shorting dollars.
The quantity theory of money is wrong, and claims about “lags” are just lame attempts to salvage a bad theory.
The Fed’s recent explosion of the money supply was accompanied by a comparable explosion of the Fed’s assets, so the amount of the Fed’s backing per dollar is not much changed. Even if backing per dollar did fall, it is likely that the Fed started this episode with a high net worth. Inflation will not pick up until the Fed has burned through that net worth. (which might not be long at the current rate!).
“If the fed is really doing something inflationary now, then the value of the dollar must fall now, or else arbitragers would cash in by shorting dollars.”
I do currency arb… and I’m shorting USD… just not on spot. It’d be crazy to go up against big players like the CBs with their swap agreements, big reserves and unpredictable (but traceable after the fact) smackdowns/shortsqueezes.
I’m using OTC options and lending T-bills 6 months ahead. If I was managing a SWF, I’d be doing what th Chinese are doing…. you think they’re not taking steps for protection? They’re just not doing it out in the open… that’s why they only recently admitted their huge gold buys, 6 years after the fact…
“If General Electric has a bad year, there will not be “long and variable lags” before GE’s stock price falls.”
WTF is this numbskull saying! Did you look at LEH or FNM or C stock chart? It takes time for people to digest news and even longer for bad investment to reach P&L and balance sheets… Enron didn’t collapse straight away… they got away with their lies for quite a long time.
Very good article. Writing from the UK, I focus on the activities of the Bank of England. I am concerned because they seem to be trying to persuade us that M4 growth is nowhere near as high as we thought it was by deliberately changing the definition of broad money that they want to focus on. If you trawl through their website you will find that the growth rate of the traditional M4 figure for May 2009 was 16.6% on an annualised basis. But the figure they are now publicising in the press is what they call ‘M4 excluding the deposits of other financial corporations (OFCs) that specialise in intermediation between banks’. They say that they prefer this figure because it takes out distortions caused by non-bank financial institutions. Apparently this version of M4 was only up 2% year on year. Is this a deliberate attempt to obfuscate the true growth rate of the money supply or am I being too suspicious?
I’m just trying to understand all of this stuff, so please take my comments in that vein. The following seems incorrect to me:
“From August 2008 to May 2009, the monetary base in the United States more than doubled. The bulk of the expansion reflects an unprecedented rise in banks’ excess reserves — that is, banks’ base money which is available for additional credit and money creation. People are being told by governments, central bankers, and leading mainstream economists that such a policy wouldn’t be inflationary — because the money would remain in the portfolios of banks and would not spill over into the hands of firms and private households. This is, to put it mildly, an uninformed view …”
This seems challengeable on two fronts:
1. Japan provides a clear counterexample. From June 2001 to April 2003, Japan’s monetary base increased by 50%. Yet this never translated into any serious money creation. If all the banks do is sit on their reserves, this won’t increase the money supply. That’s exactly what happened in Japan. Note, the Fed now actually pays banks interest on excess reserves, so unless there is more *push* from the government, these banks could just sit on these reserves for years and years until eventually they clean up their balance sheets. Not a good situation, but not one that leads to exacerbations of the money supply.
2. It would seem to me the problem (as far as price levels) is not from excess reserves, but from the method used for the creation of the new money to begin with. It would seem the Fed is engaging in a veritable alphabet soup of programs, whereby it not only lends money out using dubious assets as collateral but also buys up dubious assets outright. If, as in Japan, all the Fed did was to lend money directly to banks (and presuming banks only sat on the money), the fed could eventually hope to take this money back. [Bad policy, but one with out serious price increases.] However, if in the future, the Fed decides to reduce the US monetary base, how will it do it? Will it foreclose on loans made against dubious assets? Will it sell off the dubious assets it has bought?
I might be reading Mr. Polleit’s arguments incorrectly, but it seems his emphasis is on the excess reserves, whereas it should be on the method through which the excess reserves were increased. If his argument is not nuanced enough, Japan would seem to provide a clear counterexample. Indeed, though I cringe at the mere mention of his name, Paul Krugman has made such an attempt:
Way off base:
http://krugman.blogs.nytimes.com/2009/06/13/way-off-base/
to japan matt:
as flix said in an earlier post, money, being fungible, may not flow into goods/services that are traditionally used as price benchmarks (cpi/ppi).
in the case of japan, the money growth designed to cushion the effects of the domestic bubble implosion fueled the carry-trade that helped generate bubbles in offshore asset markets (read us).
it’s quite possible that the money growth exercise in america today will fuel an asset-bubble in asia or commodities or both.
Mike Sproul
Shadowstats has the CPI at 8%, but the monetary expansion is far greater. It takes time for their to be domestic price corrections; but on the Forex market speculators will move the ER’s in the correct direction (not saying to the right price, but in the right general direction). The J-curve demonstrates my point.
matt
The case of Japan is an interesting one. The Japanese people have an enormous savings rate, I believe 20% of GNI. The Japanese also don’t have vehicle currency status financing massive current account deficits (7.7% of GDP for the U.S in 2006). Furthermore, their culture is entirely different; using credit is looked down upon. Credit cards are like ATM cards in Japan, people pay them down immediately, not over extended periods of time. Either way, the massive monetary injections have not helped Japan, and they are in the middle of two lost decades. America and Japan are very different.
My favorite part is the sad irony of all of this. There is no better example of irony than the American manufacturers liking policies of inflation. They think that they are getting a currency break while they go bankrupt. As the value of the dollar goes down, people make less wealth. Consumers then tend to spend their money on the lowest cost producers instead of the higher margin high quality producers. In other words they gravitate to products made in China, Pakistan, Korea, etc away from the US, Canada, Europe, etc.
It is like the ancients bleeding patients to help them heal. It just kills them faster.
The answer to this guff as explained by the Skeptical Optimist.
Inflation (deficit spending) is an efficient way to redistribute real wealth.
If, for example, the government wants to hire a policeman, by using inflation, it takes just enough real wealth from the private sector to trade for the policeman’s services.
If, on the other hand, the government is using taxes to hire a policeman, the private sector has to support the tax collector, the tax accountant, the tax attorney…, in addition to the policeman.
Which way is better?
“Which way is better?”
for the taxpayer or for the govt.?
Witholding is also really efficient… now, how did that work for tax rates?
Curious, which way is better? Funding my activities by entering your home when you’re away and stealing things that you won’t immediately notice are gone, or knocking on your door and demanding money with threats if you don’t pay?
Even though running the printing press might be more efficient for the government, it hurts the efficiency of the market by sending false signals. And of course it
I think Prof. Polleit says which does not garner enough attention is a focus on the EMH, the fact that the market *prices* in inflation instantaneously by supporting the current price. The focus on any other fact is extraneous… the inflation from monetary creation is *instantaneous*, the subsequent rise in prices following this event in short order in this “inflation” is “malinvestment”. Pay heed to that, and you’ll be ready. Don’t buy gold and silver yet my friends.
Most governent figures are “dreamed up” the ECB says Inflation is zero, my wife tells me she is having difficulty coping and needs more script money, either I give it to her or I go hungry, a pretty compelling argument. I wonder where Trichet lives?
*sigh*
The link:
http://www.optimist123.com/optimist/2008/12/purchasing-power-propaganda.html
Trading in the Forex Marketplace can be very attractive. However, you should also know that there have been people who suffered extreme financial losses in the Forex Marketplace. It is true that the Forex Marketplace offers a very good money-making opportunity to a lot of people, but it also has its risks.
Comments on this entry are closed.