How Does Inflation Work Anyway?
How will inflation work in any case? Monetary policy, central inflation, and bank are hard. It’s well to remember that. Today’s blog post adds up a few things that seem like they’re obvious but are not. Central bankers are puzzled at low inflation persistently. Ms. Yellen said, as the “biggest surprise in the U.S. Of course, they’ve been planning on that for several years now.
She cautioned, however, that U.S. That’s not criticism. Inflation is hard. Why is it so hard? The standard story will go, as there is less “slack” in the product or labor marketplaces, there is certainly pressure for income and prices to move up. So that it stands to perfect reason that with unemployment low and after years of tepid but steady growth, with quantitative measures of “slack” low, that inflation should rise, as Ms. Yellen’s first quotation opines.
That paragraph contains a classic financial fallacy, that of composition; the dilemma of comparative prices and the known level of prices and income overall. If labor markets “tight get,” companies are finding it difficult to find workers, then yes, one expects wages to rise. But one expects wages to go up relative to prices.
You only tempt workers to move to your company by offering them wages that allow them to buy more. Similarly, if there is strong demand for a company’s products, its prices will rise. But those prices rise in accordance with other prices and to wages. Supplying an ongoing company higher prices when its wages, costs, and competitor’s prices are all rising does nothing at all to get it to produce more.
So, in reality, standard economics makes no prediction at all about the relationship between inflation — the number of prices and income overall; or (better) the worthiness of money — and the tightness or slackness of product and labor markets! The fabled Phillips curve began as a solely empirical observation, without theory.
By the way, the oft-repeated mantra that “inflation objectives are anchored” offers no solace. In fact, it makes the puzzle worse. Variant in expected inflation can be an excuse for a Phillips curve failure usually. Steady-expected inflation means the Phillips cure should be better! But beware that anchor. Is it anchored or just not moving?
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Is policy limited or loose right now? You’d think this was a simple question. The newspapers band with “years of amazing stimulus” and “unusually low rates.” And even, rates of interest are low by historical requirements and relative to guidelines such as John Taylor’s that summarize the successful parts of that history. But ponder this. Exactly what does a central bank or investment company appear to be that is keeping interest rates down? Well, it would be financing out a whole lot of money to banks, who would turn and re-lend that money at higher interest rates around.
What will our central bank or investment company appear to be? 2.2 trillion from banks, and it is paying them an increased interest than they can get somewhere else. At this time, the Fed is paying banks 1.25% on their reserves. But Treasury expenses are 1%. Commercial paper is 1 Even.13-1.2%. It appears every bit just like a bank or investment company that is pressing rates up. And is doing so for a long period. How is this possible remotely?