. . . I get a stupid answer.
A recent article on inflation beautifully illustrates the truth of this old adage. Before we begin the article, let us review another proverb that is not old at all.
Please do not make inferences due to price changes.
So, for example, it makes no sense to ask people about the “welfare costs of inflation” without first specifying whether inflation is caused by a decrease in supply or an increase in demand. But that doesn’t stop pollsters from asking. here economist (Excerpt from an article titled “Is Inflation Morally Wrong?”):
Americans who responded to Stantcheva’s survey were angry for several reasons. Most people believed that inflation inevitably meant a decline in real income. They said they had become concerned that rising prices would make life more difficult and even basic needs unaffordable. Respondents did not see a trade-off between inflation and unemployment, which economists call the “Phillips Curve,” but thought both would rise simultaneously. About 70% viewed inflation as a sign of “poor conditions” rather than a sign of a booming economy.
Note that all popular beliefs are true if inflation is caused by an unfavorable supply shock, and false if it is caused by a positive demand shock. Now contrast these views with those of economists.
So why are some economists more relaxed about rising prices? Inflation presents challenges. It could undermine the credibility of central banks and lead to arbitrary redistribution from creditors to debtors. Constantly updating prices also incurs costs for businesses. But if all prices are adjusted by the same rate, the changes are not as significant as many workers believe. This doesn’t mean workers are getting poorer, any more than measuring someone’s height in feet rather than centimeters means they’re getting shorter. Additionally, inflation is often the result of a hot labor market.
Economists’ views are largely correct if inflation is caused by positive demand shocks, but can be quite misleading if it is caused by unfavorable supply shocks.
There isn’t much the public and economists disagree about about inflation. Rather, they are discussing a completely different concept. This is like combining the decline in coffee prices due to caffeine cancer fears with the decline in prices due to a bumper coffee bean harvest. The impact on consumer welfare is not the same!
Consider the following two views that are widely accepted by many people:
1. The public hates high inflation.
2. An independent central bank is needed because politicians are tempted to enact expansionary monetary policies to popularize the economy.
Do you see a conflict here? This problem can be solved, or at least greatly reduced, if we distinguish between supply-side inflation and demand-side inflation. Clearly the public dislikes supply-side inflation, which is linked to falling standards of living. Demand-side inflation can also be somewhat unpopular in some cases (as it is now), but this case is much more ambiguous. Here are some counterexamples:
1. Between 1929 and 1933, monetary tightening reduced the cost of living by about 25%. However, President Hoover was very unpopular.
2. Between the spring of 1933 and the spring of 1934, FDR’s expansionary monetary policy raised the cost of living by about 10% (this is well above the 2022 inflation peak). FDR was very popular.
3. Between 2008 and 2009, tight monetary policy led to a sharp decline in inflation to almost zero. People thought the economy was in bad shape.
These three anomalous examples of public opinion moving “in the wrong direction” in response to changes in inflation all share one thing in common: In each case, changes in inflation were caused by demand-side shocks. This reflects the views of economists. economist article. I am not claiming that demand side inflation is always popular (it is not). Rather, the welfare effects of supply-side inflation and demand-side inflation are significantly different, and the public has at least some ability to detect this difference. For example, supply-side inflation reduces real income, while demand-side inflation temporarily increases real income (i.e. real GDP).
Many at the Fed think NGDP targeting is a bad idea. One argument I often hear is that the public understands inflation targeting, but not NGDP targeting. Nothing could be further from the truth. NGDP targeting is much easier to explain to the public.
Fed officials, suffering from the delusion that the public “understands” the Fed’s inflation targeting policy, go to town meetings and say that if inflation falls to 1%, the Fed will raise inflation back to 2% (or even 3% like FAIT). Check out the incredulous expressions on their faces. Yes, some in the public have heard vaguely about the Fed’s 2% target, but they assumed that meant the Fed was trying to keep inflation from exceeding that level. Not one person in a hundred understands the essence of inflation targeting, which is to assume that 2% inflation is actually a good thing and then have to cover the cost of living if inflation falls below that level. Climb faster.
It could be argued that NGDP suffers from inverse asymmetries and that the public does not understand why too high NGDP growth is a bad thing. In reality, the asymmetry of NGDP is much less of a problem. You need a PhD in economics to truly understand why high inflation can reduce unemployment. (Sometimes that isn’t enough. Inferences from price changes.) On the other hand, if you tell ordinary people that a very rapid increase in popular income can lead to a problem of high inflation, they will understand to some extent.
The Fed needs to tell the public that monetary policy is not about interest rates, inflation, or unemployment. Monetary policy is to maintain the national income growth rate at 4% per year. full stop.
