Are Recessions Deflationary?
Over the past few months, I have become increasingly irritated with the confident press claim that recessions lead to lower rates of price inflation. For reasons that I myself do not understand, a recent Wall Street Journal piece pushed me over the edge, and the article you are now reading is the fruit of my frustration. By the end, I hope to convince you that both theory and history show that economic downturns lead to higher price inflation, other things equal. FULL ARTICLE
Comments (53)
Very interesting. But wouldn’t increased savings and lower employment reduce consumption and offset lower production?
Published: April 28, 2008 8:32 AM
It is unfortunate that the people at the Fed (and some of the people at the W.S.J.) do not understand even the most basic economics.
Even if we define inflation as a higher general "price level" (using some index or other) if production falls and the money supply does not fall then prices are going to be HIGHER (not lower) than they would have been if production had not fallen.
The above is basic logic - but for those people who insist on empirical examples.....
In some countries and periods in the 1970's price inflation and unemployment borth rose (so no "Philips Curve" trade off) and production fell. Nor was this just about the "oil shock" of 1973.
Indeed in both Britain and the United States governments had already introduced price controls before 1973 (1971 in the United States and 1972 in Britain) in a demented effort to mitigate the effects of their own increase in the money supply.
As for higher savings meaning lower prices - yes but not in the way "fundementalist" thinks.
If increased savings are used for productive investment in betters ways to make goods and services then the prices of these goods and services will be lower (in the long term) than they would have been if savings had not increased and been used in this way.
However, fundementalist is not pointing at this - what is being pointed out is one of the doctrines of Lord Keynes and the "keep up demand" people.
The doctrine that savings are somehow a "leakage" from the economic system (as if saving money means keeping it under the bed), and that what drives an economy is not work and investment but, rather, consumption.
President Bush is a classic example of this sort of thinking - hence his reaction to 9/11 "go out shopping to keep the economy strong".
Such a view is in error.
Published: April 28, 2008 9:13 AM
Recession or not, how could you have any deflation when the government is spending and borrowing so fast it makes you're head spin. Its like being worried about your roof leaking, so you move all of your stuff out into the yard.
Published: April 28, 2008 10:32 AM
Actually, looking at Murphy's graph, it seems to me that for 7 of the 8 recessions shown, % increases in the CPI either halted their climb or fell in all but one instance, the 73-74 recession. Does anyone disagree with this observation? I'm not sure, therefore, how Murphy's graph does not fit the conventional wisdom.
Published: April 28, 2008 11:23 AM
"Other things equal, lower real output will yield higher rates of price inflation."
As someone else pointed out, would the decreased consumption of goods not ease the demand pull inflationary pressure against the available supply of goods, thereby mitigating inflationary pressure relating to demand and labor.
I appreciate your graphs on recessionary inflation, however, I do notice inflationary spikes correspond to times of higher oil prices; a jump in primary material costs. Middle East oil tensions and the US stagflation crisis.
“In the U.S., Fed officials are concerned that food and energy prices have increased inflation even though the economy is sliding into recession. But they are generally confident that inflation will recede as rising unemployment prevents workers from winning wage increases. “
"Inflation almost always falls during economic downturns. The Fed has history on its side," says Julian Jessop, an economist with Capital Economics in London. He expects inflation to be much lower globally a year from now, and the new IMF forecast does, too. “
It seems to me that no one is denying that primary material cost push inflation is driving our price increases, however, they seem to agree we will have reprieve due to decreased wage demands from a looser labor market and also from a decrease in demand, both due to a contraction / recession that was consumer led – subprime.
Published: April 28, 2008 11:49 AM
A question that I would like to have answered that seems to be overlooked because I have not seen it discussed is as follows.
Traditionally depositors lent money to the bank and the bank lent that money out paying interest to the depositors.
What happens when those depositors begin to shift their money to make direct investments in stocks or mutual funds to get a higher rate of return?
The banks now have less reserves, so how can they make as much money as they made before with the existing infrastructure they've had?
What would happen if depositors remove more of their money to invest more of it in at least money market rates of return if they are getting 0% interest in times of rising inflation?
Published: April 28, 2008 12:05 PM
Paul: "If increased savings are used for productive investment in betters ways to make goods and services then the prices of these goods and services will be lower (in the long term) than they would have been if savings had not increased and been used in this way."
It depends on which phase of the business cycle you're talking about. During the expansion, I think you would be correct. But during the recession, businesses aren't investing; they're building up their cash balances as consumers are. They won't invest those savings until confidence returns.
Published: April 28, 2008 12:23 PM
Keith: "Recession or not, how could you have any deflation when the government is spending and borrowing so fast it makes you're head spin. "
If you're referring to federal and state governments, fortunately they don't expand the money supply. They must borrow or tax, so they just recycle money they have taken from citizens. It's increases in the money supply by the Feds that cause price inflation.
Published: April 28, 2008 12:26 PM
Andrew: "As someone else pointed out, would the decreased consumption of goods not ease the demand pull inflationary pressure against the available supply of goods, thereby mitigating inflationary pressure relating to demand and labor."
Actually, I shouldn't have added the things about savings because Murphy specified "all things being equal" including savings.
Andrew: "I do notice inflationary spikes correspond to times of higher oil prices; a jump in primary material costs."
New money enters the economy at specific places, often in the manufacturing sector because it is a capital intensive and sensitive to small changes in interest rates. As a result, the manufacturing demand for energy and raw materials often cause their price increases to precede price increases in consumer goods. Mainstream econ sees a correlation here, but it's a spurious one. Both are effects of another cause--increases in the money supply caused by the Feds.
Andrew: "It seems to me that no one is denying that primary material cost push inflation is driving our price increases..."
Well, Austrian econ would deny it. Plus, mainstream econ completely and utterly ignores the effects of monetary policy.
Published: April 28, 2008 12:33 PM
Wow, even my neoclassical economics professors would deny that, being influenced by Friedman quite a bit ("inflation is always and everywhere a monetary phenomenon")... my economics tutor was a Hayekian, and he actually made sure to point out in one of our lectures that cost-push "inflation" is pure nonsense, as it refers to a phenomenon pertaining to falling supply, not an expansion in the money supply, which is what is in actual fact being inflated (prices do not "inflate" - they rise or fall.)
Published: April 28, 2008 12:51 PM
The velocity parameter in the equation (of exchange) is a reflection of the demand for money which is a psychological parameter, not some measurable physical quantity. Rather, demand is a derived term that is computed by considering the supply and price of commodities, including money.
It's a bit like the relationship between speed, distance, and time. Which is directly measurable and which is merely the result of the other two?
For example, how would one measure the effect of the anger that some foreigners have for the US which has led them to demand less dollars. Or what about the demand for American made products that comes from the desire to buy American that some Americans claim to have. How much does the one offset the other? Can this even be determined?
Similarly, the Chinese are demanding dollars for a variety of psychic reasons. We cannot measure this demand directly (we don't have brain scanners that good yet) so we compute it indirectly from what can be measured, the supply and prices of goods or monies. What is seen then is that the Chinese are holding a large supply of Fed cash, for some psychic benefit.
As to the great depression, one would need to factor in the amount of government pressure that caused some prices to remain high, such as the price of wages. With so much interference in the markets by Hoover and FDR, it's quite difficult to factor out the various causes of the depression and separate this from the deflation that also resulted from the failure of so many banks. I tend to trust Rothbard's explanation, but there's no simple equation of exchange that is likely to provide us with much insight. And unless we separate out the multitude of causes, it's going to be pretty much impossible to determine which effects come from which causes. The data and charts are also suspect, so I tend to think that logic is the best tool to use but it is not able to make perfect future predictions either.
Published: April 28, 2008 1:28 PM
Mark, thats an interesting question indeed.
In my thinking, the banks are reliant on venture capital and debt creation to make money, not having sufficient 'reserves' hasn't seemed to slow them down. They utilize the money multiplier equation to determine how much more money or debt can be created from the existing deposits. Its a considerable leverage so I don't think the established banks are ever short on available supply of debt to market, more that they become short on demand for debt, with an economic contraction and market share of debt, as they compete with other banks. Accompanying a slow down in the economy is a slow down in debt creation and capital ventures, bank profits will decline with the decrease in consumer, business and investor confidence.
Do I think that migration of savings from bank accounts to stocks and bonds in times of low rates would affect bank profits? I think that this would be offset by the surge in debt creation accompanying a time of low rates. People with existing capital or deposits who are not dependent on credit I would think have their money already earning higher rates of return in stock and bond markets. I wouldn't imagine that a high volume of stagnant deposits exist in bank accounts, in fact in Canada, there are regulations about how much money you can have in checking and savings account. Once you have a certain amount, it has to be invested in stocks or bonds.
Published: April 28, 2008 1:42 PM
To me the argument is Kantian semantics, if cost push inflation is nonsense, it is only so because demand pull factors are the only "reality", and that primary materials would not increase in price without an increase in demand. Like Eric's comments on speed, time and distance. So I will say that rising prices of goods, not inflation, can be attributed to increased demand for primary materials. How can we dissect to what degree our price increases are resultant of different inflationary pressures; monetary, demand, materials? I don't wholly subscribe to any one factor.
Fundamentalist "As a result, the manufacturing demand for energy and raw materials often cause their price increases to precede price increases in consumer goods."
This is a direct function of consumer demand, business expansion is a calculated response to market forces. So is there any difference between manufacturing and consumer demand for materials?
In an exchange between Bernanke and Ron Paul I was interested to see Paul point out that oil was stable against the price of gold, but has risen against the dollar, trying to back Bernanke into a corner on monetary inflation. Bernanke came back and said that he agrees that oil is an inflationary pressure. I was surprised Paul didn't nail him on that.
Published: April 28, 2008 2:24 PM
What this article does is question the validity of the assumption that we will see price deflation. It is questionable why we see one or the other, of course. Since price changes should be relative to changes in the value of money.
One of the major problems in economics (and as one can see from this article) is the lack of good data. Consumer price indexes, inflation, and GDP are all data that are not reliable as readers of this site well know. So then, how should we use this data? Well simply, in this article's case, its a matter of using data that others trust to show them how their arguments are wrong.
But I'm still skeptical of what the real numbers are for price inflation during real recessions. I'm not talking about federally defined recession (based on 2 consequetive quarters of declining GDP), but rather any real terms of economic recession using reliable data.
Unfortunately, due to the cost of gathering and analyzing this data it is lacking. And we'll never have the accurate historical data that we would need to compare it to.
But if we define recession as any period where there's a decrease in the output of a nation, and compare to various price indexes, perhaps we can start to have an understanding of the effect.
Better yet, is there data available for output by state or city? This way we could see some of the effects that local recession (instead of national or global) has on prices.
A hefty amount of work for sure.
Published: April 28, 2008 2:38 PM
What about investment liquidation? If a recession is allowed to proceed without too much government intervention and bailing out, we should see lots of businesses closing down and liquidating their investments. This liquidity is not immidiately re-invested because of low confidence, but may be re-invested during later stages of the recession as the economy starts to recover again.
However, at least in the first stages of the recession, will liquidation not cause an increase in the demand for money, thus raising its value? I remember Rothbard pointing to something along those lines in his book The Great Depression. That is of course if the Fed doesn't expand the money supply.
Published: April 28, 2008 3:07 PM
I second Alex's question: how does that chart disprove conventional wisdom? It seems to support it. Almost every recession was accompanied by a subsequent downtrend in the CPI. Since Murphy seems to be making the argument is that CPI (as defined by govt) will not fall due to recession (as defined by the govt), that chart needs some 'splainin.
Published: April 28, 2008 3:11 PM
Well, finally someone responds to my remark concerning Murphy's chart that he said did not support conventional wisdom that most recessions coincide with a dampening of the rate of CPI increases. But the response agrees with my observation. What now at least two of us are looking for is an explanation of how Murphy manages to view the chart the way he does. Or perhaps someone else here can explain how to view the chart the way Murphy does. This is far from an inconsequential issue, since Murhpy stated at the outset of his paper that the historical data shows the conventional view that most recessions accompany price inflation dampening is wrong. Well then, how the heck does Murphy's chart show that?
Published: April 28, 2008 3:27 PM
Andrew: “How can we dissect to what degree our price increases are resultant of different inflationary pressures; monetary, demand, materials?”
Generally, demand will not increase across the board for all commodities or consumer goods at the same time. Let’s assume a fixed stock of money. Demand driven prices increases focus on one or two items and occur because of a shift in consumer tastes, or new technology, or an accident that shuts down a factory. When those things happen, the price of the item in demand will increase, but since buyers have a fixed amount of money, they’ll have to cut back on the purchases of other things in order to pay for the demanded item with the higher price. So one item with greater demand also has a higher price while other items with lower demand have lower prices. Prices in general don’t rise. We just see a shift in demand from some items to others.
When prices rise across the board, commodities, services, consumers goods, all within a short period of time, you can bet that it’s caused by an increase in the money supply, otherwise, where would people get the extra money?
My son plays the online video game Guild Wars and he was telling me that the price of most items had increased dramatically. My guess from his description is about 500%. I asked him why he thought that happened. Not knowing any econ, he said it was because some players had figured out hacks that allowed them to give themselves as much gold as they wanted. What a game!
Andrew: “This is a direct function of consumer demand, business expansion is a calculated response to market forces. So is there any difference between manufacturing and consumer demand for materials?”
This goes to the heart of Austrian econ and is a chicken-egg question. Which comes first, consumer demand or production? Keynes said consumer demand. Austrians subscribe to Say’s law: demand for goods is not a demand for labor (was that Say?). To put it another way, production creates demand for consumer goods, not vice versa. Consumer demand realocates production from one industry to another, but it doesn’t cause an increase in production across the board. Investment does that by hiring new workers and paying them wages. Since they spend most of their wages on consumer goods, the new workers hired for production created the demand for consumer goods.
Demand for manufacturing goods, such a raw materials, comes from increased investment, too.
Andrew: “Bernanke came back and said that he agrees that oil is an inflationary pressure. I was surprised Paul didn't nail him on that.”
Bernanke, being Keynesian, probably didn’t understand what Paul meant and Paul may not have felt like instructing him in real economics. I read a research paper from the San Francisco Fed a few years ago where they analyzed whether oil prices or monetary policy drove increases in inflation indexes. The researchers came down on the side of monetary policy. I’m sure you could find the article if you searched their web site, but I can’t remember the name of it.
Published: April 28, 2008 5:02 PM
Andrew: You said, "...in Canada, there are regulations about how much money you can have in checking accounts. Once you have a certain amount, it has to be invested in stocks or bonds." This is an interesting statement. I would like to get a reference to check the precise nature of such regulations. Andrew, could you please provide a reference? Thanks.
Published: April 28, 2008 5:50 PM
"To me the argument is Kantian semantics, if cost push inflation is nonsense, it is only so because demand pull factors are the only "reality", and that primary materials would not increase in price without an increase in demand. Like Eric's comments on speed, time and distance. So I will say that rising prices of goods, not inflation, can be attributed to increased demand for primary materials. How can we dissect to what degree our price increases are resultant of different inflationary pressures; monetary, demand, materials? I don't wholly subscribe to any one factor. "
It isn't "Kantian semantics". The one is due to increasing scarcity (unless it too is being caused by an inflated money supply), the other due to monetary mismanagement. It only works to the central bank's advantage to have these issues shrouded in obfuscation and mystery. Inflation is inflation, and rising prices are rising prices. The latter tend to be symptomatic of the former.
Published: April 28, 2008 6:01 PM
"Wow, even my neoclassical economics professors would deny that, being influenced by Friedman quite a bit ("inflation is always and everywhere a monetary phenomenon")... my economics tutor was a Hayekian, and he actually made sure to point out in one of our lectures that cost-push "inflation" is pure nonsense."
"Inflation is inflation, and rising prices are rising prices. The latter tend to be symptomatic of the former."
If I am describing a scenario in which goods become more expensive due to primary material cost increases, I'll use the term, cost push price increase.
Its just sometimes, I have seen inflation used as a term to describe price increases arising from factors other than inflation of the monetary supply, maybe this is wrong? Maybe the terms should be separated to avoid confusion?
Calling cost push inflation nonsense only to say its a price increase later, could have been replaced by explicitly defining your terminology labels for each mechanism of inflation or price increase. But now I know what you mean.
I agree the central bankers use the term inflation as a blanket and are currently trying to hide their poor conduct of monetary policy under "cost push inflation", pointing their finger at oil, which I said previously, no one seems to deny in the mainstream, except Ron Paul.
Alex- I have personal experience with this one, an extended family member who inherited. The limit for checking accounts at CIBC was 1 million dollars, I asked my relative why he doesn't put more in his checking account, he said he could not, it was not allowed. As far as savings go, I know he said they required him to invest. His total cash assets are aprox 6 billion, I've seen the paperwork. Its common sense, how could they let you plunk huge sums of money required to feed the economy in savings accounts? I will get the banking ombudsmen to direct me to the appropriate resource to source this. The system is designed to keep the cash in motion, changing hands, capital flows. People with money do not spend on debit cards, they spend on credit cards with huge limits whilst their money is earning in the market place.
Published: April 28, 2008 7:23 PM
Actually, looking at Murphy's graph, it seems to me that for 7 of the 8 recessions shown, % increases in the CPI either halted their climb or fell in all but one instance, the 73-74 recession. Does anyone disagree with this observation? I'm not sure, therefore, how Murphy's graph does not fit the conventional wisdom.
That's one way of describing it. Another way is to say that recessions apparently drive up price inflation, very clearly in 5 of the recessions, and somewhat in a 6th.
Suppose we graphed temperatures over a 20-year period based on quarterly averages. I.e. for each year we plotted the average temperature for Jan+Feb+March, then for April+May+June, then for July+August+September, and finally for October+November+December.
Then someone says, "You know, usually during the summer it gets really cold."
I might argue with this, and point to the graphs. During the summer months, the temperatures would spike up, relative to the surrounding quarters.
Yet you could quite correctly point out that during every summer quarter, the rate of temperature increase reverses. I.e. temperatures were rising going into the summer months, but then after peaking in the summer they always fall back down.
Clearly then the summer has a cooling effect.
Published: April 28, 2008 8:01 PM
Andrew: I very much look forward to getting that information concerning the regulation on the maximum amount of money an individual can hold in a Canadian bank (checking account or savings account). Such a regulation certainly does not make common sense to me. When I deposit $10 million into a checking or savings account there is no loss of circulation of this money. The bank invests my money by granting credit. Why would any authorities force me to deposit $10 million in 10 banks rather than one? And why would any authorities regard it better that I personally invest my money directly rather than through financial intermediation? And why would Canadians put up with such restrictions on their financial freedom? Has any other Canadian (who may be on this blog) ever had experience or heard of such restrictions?
Published: April 28, 2008 8:42 PM
Bob Murphy: Your example of a seasonal quarterly temperature graph would show temperature peaking in the summer (of course) and then temperature falling. No one would argue that the summer causes the subsequent falling temperatures just because the summer always precedes the falling temperatures. We know the position of the earth (the angle) relative to the sun which causes the seasonal temperature changes. In the Northern hemsiphere the angle of the rays hitting the earth is closer to 90 deg than in the spring, fall and winter months.
But, with regard to CPI inflation, one theory argues that diminished economic spending that occurs during recessions directly and indirectly (through effects on wage demands, etc.) has a dampening effect on inflation. This is the conventional wisdom you are attacking. When you say the historical data of the graph is inconsistent with this conventional view, it is clearly not, since in all but the oil price shock recession of the early 70s, CPI inflation has declined during and after the recessionary periods appearing in your graph.
Can you explain with reference to your chart how in 5 or possibly 6 of the 8 recessions depicted it appears as though CPI inflation has increased either during or following these recessions?
Published: April 28, 2008 8:57 PM
Alex- "When I deposit $10 million into a checking or savings account there is no loss of circulation of this money. The bank invests my money by granting credit. Why would any authorities force me to deposit $10 million in 10 banks rather than one?"
It is not a question of depositing 1million in 10 banks, if you had 10 million, or something like this, if thats what you were saying. Its a question of where your money has to be while its in the bank, where they direct it to. Banks primarily make more money off debt, mortgages, rather than investment banking operations. Each mortgage gets enough credit in the system to create itself with the down payment thats paid, because of the money multiplier equation. I said before, I do not think they are hard up for creating credit, they seem to have a knack for it. Most people are profitable to the bank by carrying debt, not by being investors, the interest off the debt allows the bank itself to invest. So if they have a 6 billion dollar cash deposit, they are not relishing at the thought of creating 60 billion dollars in mortgages, because who the heck is going to carry them? They are already competing like savage dogs over mortgage customers, with the unreal estate market, everyone has a huge mortgage now, in our unburst bubble nation. The stock and bond markets via their high priced investment banking division takes care of it. I will post the regs when I get them.
Published: April 28, 2008 10:17 PM
Can you explain with reference to your chart how in 5 or possibly 6 of the 8 recessions depicted it appears as though CPI inflation has increased either during or following these recessions?
I don't know how it could possibly be clearer. CPI increases were highest during 5 of these recessions. If my theory is right, that is exactly what the chart would look like.
You seem to think that my theory would imply that CPI goes up during the recession, then keeps shooting up afterwards, because of the "kick" the recession gave it. But no, after the recession is over, the lifting from the recession is also over, so CPI falls.
Again, it's like you're arguing that summer leads to cooling because temperatures rise going into summer, then fall after summer--rather than continuing to rise after summer is over.
You try to avoid that by explaining the theory of temperature increases. Right, we know why the graph looks like that. But suppose someone disagreed with your theory. He would then use the same arguments you are using on me with regard to CPI.
You can say we should just argue about it in abstract. But if we're going to use charts to try to decide which theory is right, I think it clearly helps my case that inflation peaked during 5 of the 8, and possibly a 6th. That is exactly what my theory predicts you would see.
Published: April 28, 2008 10:34 PM
Bob Murphy writes:
"maybe this third variable — the growth in the money supply — was the foundation for the conventional wisdom"
This is possible, but has it been disproved by charting CPI? I would be more interested in an index containing house prices and stock prices as well as retail prices. Or alternatively chart MZM instead of CPI.
Still, it's interesting how retail prices fare during a recession. The chart suggests that a recession often terminates a steep rise in CPI, and also that CPI often falls when the recession has ended.
Published: April 29, 2008 12:52 AM
Alex,
I'm with you.
When I look at the chart start and finish dates of each of the 8 recessions, I see the inflation rate is lower at the end of the recession than at the start, for 7 of them.
In other words, the chart seems to support the opposite view of the author, i.e. recessions cause inflation to fall. And, for a time, the effect is sustained after the recession ends.
Published: April 29, 2008 5:34 AM
I would have thought it was plainly obvious that most (not all) of the recessions were preceeded by inflation and followed by deflation.
Simply:
1. Expansions in money supply cause INFLATION.
Such excess money and inflation causes out of control asset price bubbles and excess capacity which lead to loan defaults and reductions in bank lending, ultimately leading to a RECESSION where real economic growth is negative.
This reduction in bank lending also causes a reduction in the money supply leading to DEFLATION.
Published: April 29, 2008 6:03 AM
I would have thought it was plainly obvious that most (not all) of the recessions were preceeded by inflation and followed by deflation.
Simply:
1. Expansions in money supply cause INFLATION.
2. Such excess money and inflation causes out of control asset price bubbles and excess capacity which lead to loan defaults and reductions in bank lending, ultimately leading to a RECESSION where real economic growth is negative.
3. This reduction in bank lending also causes a reduction in the money supply leading to DEFLATION.
Then we start the cycle all over again.
Thank you and come again.
...from
The Fed ^_^
Published: April 29, 2008 6:04 AM
Andrew, yes, it's just important to retain in mind the conceptual distinction between inflation, which is a monetary phenomenon, and rising prises due to increasing scarcity.
Published: April 29, 2008 7:18 AM
Anyone who thinks recession leads to lower prices needs to visit Zimbabwe!
Published: April 29, 2008 8:29 AM
George:
The recession in Zimbabwe did not have the same cause as the ones in this example. In Zimbabwe there was a sudden drop in Real GDP as a result of physical interventions into the market by the military (expropriating white farms).
This caused a dramatic reduction in the production of goods and services in the economy because farming was the dominant industry.
A reduction in goods and services whilst the same amount of money exists lead to prices rising fast. In mathematical terms the nominator increased whilst the demoninator decreased exponentially increasing the resulting number:
Money Supply / Goods&Services = Inflation
As the recession continued the government printed money hand over fist to pay for IMF loans and other purchases within Zimbabwe and overseas. = MONEY SUPPLY INCREASED MORE
But all the while the Economy did not expand much because many of the farms = ECONOMY STAGNANT
The net result is that since Independence (1980) and especially since recent violence (2007) the goods and services have grown slowly whilst the money supply has run away in exponential amounts.
This is not comparable to economies where strong GDP and money supply growth (=inflation) is experienced prior to a recession, upon which time the government raises interest rates very high to curb inflation thereby causing banks to restrict lending for a period (=deflation). Once inflation has been reduced the government starts to reduce interest rates to stimulate the money supply and it all starts again.
This is commonly referred to as the BUSINESS CYCLE.
It has no relationship to Zimbabwe which is not experiencing business, let alone a cycle.
Published: April 29, 2008 8:52 AM
Bob Murphy: When A precedes B, we all know that this does not imply A causes B. We know it for obvious reasons with regard to high temperatures in the summer and lower temperatures that follow.
"...the same arguments you are using on me with regards to CPI."
Bob, the only "argument" I have is simply a question of how you can say that your chart does not show that recessions generally coincide with slowdowns in CPI inflation, when (as you can now see) for a number of us they seem to show exactly that, and not, as you suggest, the opposite. Is there something wrong with our eyesight, or what?
Published: April 29, 2008 9:40 AM
Mr Murphy
I have no bones to pick with this article as far as it goes. It does make me wonder though.....
1. Isn't the principal culprit for the entrenchment of 'conventional wisdom' the undead Phillips curve, which depsite having been completely refuted, retains a sort of factoid status, an axiomatic acceptance that there is a tradeoff between employment and inflation, glibly segued into a similar tradeoff between growth and inflation. This among people who really should know better!
2. You have my sympathy in being constrained to use CPI figures for making your Austrian point! The limitations of this sort of indicator* are legion, not least of which is that the price movements of different components of the mythical basket occur at different times and at different rates, making the measure a backward-looking number - but how far backward-looking it is impossible to ascertain. Such CPI numbers dated according to the time of their release can not be meaningfully matched to recession periods with any sort of precision at all, but its a fair bet that the post-hoc measures should be shifted backwards in time to get a more meaningful picture of their temporal significance in relation to the recessionary periods.
3. Perhaps it is enough to reflect that whatever the CPI growth rates might have been and however they correlate or not with the recessionary periods, the most salient point is that at no stage since 1955 did deflation occur at all - we ALWAYS had some rate of CPI increase, which by itself makes nonsense of the 'conventional wisdom' relating growth to inflation and recession to deflation.
* I like to use an analogy between inflation and tuberculosis to illustrate the difference, and the analogy even extends to the CPI measure:
Price rises are to inflation as coughing is to TB.
Monetary expansion is to inflation as bacillus levels are to TB.
CPI measures are like a doctor counting how many times the patient coughs in any given period - it may yield a crisp number that can be quoted with authority, but it is of no use in treating, or even understanding , the disease. For that, you need a bacillus count.......
Published: April 29, 2008 9:47 AM
Bob Murphy: I have strained my eyes so many times to try and see the data that you see. After I wrote my previous entry, I again looked at every wiggle on the chart. Specifically, this is what I saw. For simplicity, let me refer to the recessions shown as 1., 2., etc. going from left to right.
Leading up to recession 1., CPI inflation was increasing. During recession 1., CPI inflation stopped increasing. Same thing with recessions 2., 3., 5., 7., and 8. For recession 4. inflation was increasing prior to and during the recession. For recession 6., inflation had been falling but just before the recession it increased somewhat. During recession 6., CPI inflation fell drastically.
How do you see the data recession-by-recession?
Published: April 29, 2008 10:02 AM
Andrew: I phoned the Canadian Bankers Association this morning. They informed me that their is neither a minimum nor maximum deposit regulation for depositors in any kind of Canadian bank account (checking, saving or otherwise).
As for such a regulation making "common sense" as you say, if it did make common sense, why would such a regulation not prevail in the U.S.?
Published: April 29, 2008 10:15 AM
I may be reading the chart wrong but it seems like prices increased every year and in 2 out of 8 recessions did the price increase decelerate.
Published: April 29, 2008 3:05 PM
Mort: You are reading the data correctly. However, the variable being discussed is not the price level (the CPI), but instead percentage increases in the CPI (conventionally referred to as the CPI inflation rate). Austrians do not refer to this measure as "inflation", but instead refer to "inflation" as percentage increases in the quantity of money. However, for purposes of discussion in Murphy's article he refers to "price inflation" rather than than money supply inflation. He does this to put the discussion into "conventional" economic terms used in the media.
Published: April 29, 2008 5:55 PM
Mort,
Right. Even in the recessions where my theory looks bad, there was still price inflation. It's just that the price inflation was lower through the recession, so it seems that the recession had a deflationary (or rather disinflationary) effect.
In contrast, in at least 5, and arguably 6, of the recessions, the rate of price inflation peaked. So I would argue that it's because the volume of real output slowed going into the recession period. This meant the stock of money was chasing fewer real goods and services, so prices rose very quickly. Then as the economy left the recession, real output rose and soaked up more of the money (loosely speaking of course), so this dampened price increases.
Against all of this, the overall quantity of money is always rising, so that's why you just about always get positive price inflation.
Alex, I can't argue with you any more on this. I don't know what else to say. I think recessions cause prices to go up, and so I think it looks good that they go way up during recessions.
Are you saying Alex that if there were, say, deflation of 5% during recession years, and all the other numbers were the same, that you would then DOUBT the conventional wisdom? Because then the rate of inflation would be falling going into the recession, and then shoot way up after it.
In fact, you must think that the Great Depression caused prices to go way up, right?
Anyway I've called in people from another blog. Maybe one of them can settle our argument. We are obviously thinking the other person is blind/crazy.
Published: April 29, 2008 8:12 PM
I agree that all things being equal that a decrease in output with constant demand would yield an increase in prices.
However, how can one say that demand will be constant in an environment where the availability of money is declining (as in the reduction of credit)?
Moreover considering the value-less condition of the currency, who can say what the nominal price of anything will be? We are in a situation where the value of our currency is determined by the amount issued and the amount issued is based on the level of debt notes in the fractional reserve banking system. In an environment where debt securities are being marked to market, and the existing value is evaporating on a day to day basis, how can one possible say if overall price levels are going to decrease or increase. This value will ultimately be determined by two diametrically opposed forces, (1) the ability of the FED and the treasury to print money into existence to affect (stabilize) the overall price level in order to prevent the collapse of the banking system, and (2) the willingness of the rest of the world (ROW) to accept our paper obligations in exchange for real goods. Should the ROW decline to accept any of our additional paper obligations, then the paper printing game to save the banking system will lead to an extreme inflationary environment.
Published: April 29, 2008 9:54 PM
Owen:
I agree with you.
By (incorrectly) defining inflation as rising prices, denominated in a phony fiat currency (PFC), and using government defined series such as the CPI that are purposely defined to deceive (to discount the rise in $PFC energy prices) , it is easy to arrive at bogus causes and effects.
Take today's headline, "Oil Companies have record $17 billion quarter". This would tend to lead one to believe that big-oil is making outrageous profits.
However, these profits are worth 1.7 million barrels a day. Priced in gold, this amounts to about 170,000 troy ounces of gold. Needless to say, stated in these terms this profits are nowhere near a record.
Published: April 29, 2008 10:22 PM
Let me clarify my definition of "Value-less" currency, as in a currency whose value is not set by quanitative relationship to an item of fixed value, such as gold, silver, or other commodity.
In summary should the FED/Treasury decide to let the banking system collapse under the weight of bad debt, then we will get extreme deflation, should the FED keep the banks afloat until the bad debts can be written off, then we will suffer Japanese type deflation, should the FED/Treasury decide to continue to assume the bad debts, as recently happened with Bears-Stern sale to JP Morgan, then we will see continue to see inflation (provided the ROW goes along supporting treasury paper), or should the FED/Treasury decide to nationalize all bad paper and the ROW abandon the Treasury paper, then we will see Hyper-Inflation and possible repudiation of the currency prior to deflationary collapse (as happened in Weimar Germany) and re-issue of a new currency.
Bottom line is that the value of the currency will be determined by the powers in charge of the government. This is why the founding fathers placed a requirement in the Constitution that money be redeemable in specie (gold or silver) in order to limit this power, based on there first hand experience with the Continential Dollar. This requirement is what kept the politican honest. The root of corruption comes from the printing of money that has no absolute backing. One has to only look at our history to see this. Honest Abe printed the first Greenback Dollars to fianance the Civil War. Had the dollars not eventually been directly redeemable in specie, then our currency would have faultered under the mass of this currency printing. I believe that we will soon test this principal.
Published: April 29, 2008 10:28 PM
Walt D:
The issue is not whether they are near a record. The issue is whether they are excessive.
Published: April 29, 2008 11:20 PM
Owen
Walt D:
The issue is not whether they are near a record. The issue is whether they are excessive.
....and who, exactly, defines 'excessive'?
Published: April 30, 2008 9:39 AM
Bob Murphy: "I think recessions cause prices to go up, and so I think it looks good that they go way up during recessions.
Are you saying Alex that if there were, say, deflation of 5% during recession years, and all the other numbers were the same, that you would then DOUBT the conventional wisdom? Because then the rate of inflation would be falling going into the recession, and then shoot way up after it.
In fact, you must think that the Great Depression caused prices to go way up, right?"
Let me deal with your last question first. You say, and repeat it directly above, that "recessions cause prices to go up". I never stated such a thing. But, if you think recessions cause prices to go up, wouldn't it be you who thinks that the Great Depression "caused prices to go way up."
With regard to your "Are you saying Alex..." question, as I said earlier we all know that correlation does not imply causation, and that even if A were to always precede B it does not prove that A causes B. The "conventional wisdom" has it that inflation typically is lowered by recessions (i.e., that the inflation rate is either lower during the recession than before the recession, or, at the very least, that the rise in inflation is halted (not the rise in the price level, but the rise in the rate of increase in the price level). To my eyes, and apparently to those of others at this site, this scenario appears to have occurred in 7 of the 8 recessionary periods.
Now, I'm sure you're not crazy, and in spite of my wife's opinion I don't think I am. So, it seems that the dispute has to do with how we each see the data on the graph. But, as I say, people other than myself are also perplexed at how you read the data.
Remember, you are arguing that journalists and other are wrong when they say that recessions generally bring down inflation rates. These journalists are not saying that recessions generally make the price level actually fall (i.e., cause negative inflation). You say, "I hope to convince you that both theory and history show that economic downturns lead to higher price inflation..."
For the history part, you point to the evidence from the past 8 recessions. I would love the data to clearly show that economic downturns lead to higher price inflation. That's why I eagerly read the article and strained and strained to agree with your viewing of the data. But, I'm afraid I just can't.
Published: April 30, 2008 10:49 AM
David C:
"....and who, exactly, defines 'excessive'? "
I guess that is what they are trying to determine.
BTW - and who exactly defines "self defence", "property infringement" or "non-agression"?
Published: April 30, 2008 5:48 PM
Alex;
Andrew: I phoned the Canadian Bankers Association this morning. They informed me that their is neither a minimum nor maximum deposit regulation for depositors in any kind of Canadian bank account (checking, saving or otherwise).
As for such a regulation making "common sense" as you say, if it did make common sense, why would such a regulation not prevail in the U.S.?
Then clearly the regulation must pertain to CIBC, I am waiting on a few emails here, the financial consumer agency of Canada. So if its not Federally regulated, it may be dependent on the individual banks discretion, so it would be a regulation and not a law? Anyway, my immediate families brokerage account is with CIBC so I'll email that account manager as well. Also, from what I gathered from this book; Funny Money, by former defense minister of Canada, Paul Hellyer, the US still has an 8% reserve rate, where as Canada lowered theirs to 0% under Brian Mulroney. So the idea you had about banks making money from credit creation being dependent on deposits, makes more sense in the USA than in Canada. Like I said, they are not needy for deposits to create more debt. So it that regard, it does make sense that they have a vested interest in directing your capital, especially when dealing in larger amounts than normal, also the government does as well, taxation.
The whole banking system takes on a new structure when it comes to high net worth clients, the teller at the bank doesnt even see how much the clients total worth is.
I am informed that after 2 million dollars in a regular off the street chequing account you must open a private banking account, ie; go from CIBC to the Wood Gundy Investment Banking Division, which is an arm of CIBC. Or at Toronto Dominion go to TD Waterhouse, the reason I am told this, is because all private banks report more frequently to Revenue Canada to monitor high net worth clients tax payments. My extended relative stated he was pressured, and emphasize, heavily pressured, to buy Canadian government bonds by Wood Gundy. As I said, for the aforementioned reasons, he was unable to have more money than 2 million in a regular chequing account, I previously thought it was 1 million, but its 2 from what happened at CIBC.
Published: April 30, 2008 10:41 PM
"Is there something wrong with our eyesight, or what?"
No, Alex, it's pretty clear the problem is with your mind, not your eyes.
Published: May 1, 2008 6:46 AM
"Moreover considering the value-less condition of the currency, who can say what the nominal price of anything will be?"
Gary, if you consider US currency valueless, then please send all of yours to me.
Published: May 1, 2008 7:11 AM
Audrey,
Sorry, I have already exchanged it for goods that retain value, before it lost any more value.
Published: May 1, 2008 2:58 PM
Audrey: Oh, that's terrific, Audrey. You can see from the data that recessions cause increases in CPI inflation. How about demonstrating your excellent vision and interpretation of the data, recession-by-recession.
Published: May 1, 2008 5:38 PM
Andrew:
Whereas it is true that the reserve requirements of Canadian banks are 0% of deposit liabilities, the banks have desired liquidity ratios (if you like, desired reserves/deposit liabilities). The Bank of Canada has found that it can quite easily control the money supply in the absence of "required" liquidity ratios. Any changes in reserves by the central bank, however, affects bank liquidity, bank lending and the quantity of money in Canada in a fashion similar to the way it does in the U.S., with required reserves.
"I am informed that after 2 million dollars in a regular off the street chequing account you must open a private banking account, ie; go from CIBC to the Wood Gundy Investment Banking Division, which is an arm of CIBC. Or at Toronto Dominion go to TD Waterhouse, the reason I am told this, is because all private banks report more frequently to Revenue Canada to monitor high net worth clients tax payments. My extended relative stated he was pressured, and emphasize, heavily pressured, to buy Canadian government bonds by Wood Gundy."
Something funny going on here. If Wood Gundy was doing such heavy pressuring for a wealthy client to buy Canadian government bonds, it can only be as part of their investment advice. However, it would seem as though your relative needs to get some independent (fee-for-advice, not commission fee-linked advice). It would be strange for anyone to want to hold $2 million in a checking account at any bank. Any banker seeing this would "suggest", rather than require that the client discuss his financial needs with their investment banking arm.
But again it would seem that your high net-worth relative needs the kind of financial advice that is institution and instrument independent.
Published: May 1, 2008 5:58 PM