If I’m clear on my Kalecki, wasn’t it actually govt deficits that restored profits? Won’t we just see higher corporate profits from stimulus? If not, which Kalecki component will offset the greater govt dis-saving?
I think the surprise coming for MMT types may be that this spending push results in lower real wages and higher profits.
In all fairness, no one really does. I think part of the problem is we are asking the word "inflation" to do too much. There are different types of price-change phenomenon that may have little to do with each other: 1) too much money chasing too few goods/overheating, 2) transient supply shocks/booms creating transient inflation (or disinflation), 3) loss of faith in the unit of account (e.g., USD), 4) asset price inflation.
When someone simply says "inflation" it means little to me.
I am persuaded of the opposite view. Inflation is above all a systemic phenomena. The paradigm of the Phillips curve is right. We just don't have the measure of slack appropriate for our more integrated world economy yet. In the post, I suggested one way we could go about constructing it.
(1) It's a common fallacy that 'inflation is always, everywhere a monetary phenomena'. In reality, money is created endogenously by the banks. That's not what causes inflation — inflation is completely independent of credit creation.
(2) Transient shocks can't do much. They dissipate away before having any impact on pricing decisions system-wide.
(3) There is no evidence of any loss of faith. To the contrary, the global financial system is plagued by a shortage of safe, public assets (T-bills) denominated in hard currencies.
Agree on 1 & 2 although these shocks can last a while and begin to feel like the “new normal”...it’s entirely possible things like shale oil and/or cheaper Chinese labor are transient.
As for 3, I think it’s complicated. What would be the signs and would it be too late by the time you saw them? It would be especially hard in a world where faith is being lost in all fiat since you may not get an FX signal. A boom in zero-duration, non-yielding assets could be one warning...or it could simply be a speculative boom. Is there any way to know? Another signal could be a sign that central banks are losing the ability (politically or otherwise) to tighten when needed - the jury is out I’d say.
What’s your story on the 1970s inflation?
You don’t address asset-price “inflation.” Is there no limit on wealth:GDP (especially in a world of low productivity and population growth)? Are there no long-term repercussions to “pulling forward” wealth via the discount rate? Strikes me there are potentially big consequences.
Like other frontier assets, Bitcoin is extremely high duration, not zero duration. The signal that makes sense to me is investors fleeing the obligations of the declining sovereign. That's very far from the case atm.
My understanding of the etiology of inflationary spiral of the 1970s is that expectations got de-anchored — same as the standard macro understanding. So I am with the doyens on keeping inflation expectations firmly anchored on target.
The relentless asset price booms that we've witnessed are driven by secular drivers, above all, the highly-advantageous balance of power between capital and labor, mediated by monetary policy ('wealth effect') and valuation cycles. We live in a 'good news is bad news' world, where the risk that the Fed would remove accommodation trumps the response of higher corporate earnings on asset prices.
There are definite long-term effects of «“pulling forward” wealth via the discount rate.» Above all, the secular decline in the neutral rate makes monetary policy entirely reliant on balance sheet management. So the impact of accommodation is felt most in asset valuations while there the effect on economic activity is very weak. But the central bankers don't know what else to do. They want the politicians to revive the fiscal toolkit. And that's what we're seeing finally with the Harris-Biden people.
So the big Q is when and how inflation expectations became de-anchored. Clearly we realized it too late in the 1970s. I feel like we're flying blind - we can look at the TIPS market but not much else. I have a suspicion that if TIPS were to signal de-anchoring (>3%?) we'd begin to "explain it away." We shall see.
I believe real wages fell in the 1970s so I have no idea where this "inflation is good for the working class" theory comes from. You haven't said that - but I hear it a lot, albeit slightly disguised.
Agree on how we got here with regards to asset prices. I fear we have essentially painted ourselves into a corner already. The "velocity of wealth" is currently very low. If it were to increase, the Fed essentially needs to run the process in reverse and destroy wealth to keep inflation in-check. I'm not sure that's possible as: 1) it will be politically unpopular among the powerful class, 2) it may lead to temporary falls in spending as people "freeze up" (and we essentially have a policy to short-circuit all such falls). A fiscal push may be exactly what tests this theory...
Nice write up. The global factor influencing inflation is under-appreciated, and I think you have a solid analytical way of showing it, so thank you for sharing.
That said, I'm not willing to totally toss domestic slack out of the window. Not sure how familiar you are with the SF Fed's decomposition of core PCE inflation into cyclical inflation vs. acyclical. Acyclical has been falling, likely due to technology and globalization. But the cyclical factor (which represents about 75% of the overall core PCE contribution) is still highly influenced by domestic factors. My favorite Phillips curve specification models cyclical inflation as a function of the unemployment gap (using CBO's estimate) and multifamily housing starts (relative to the population), along with a lag and a constant. Going back to 1985 this specification explains 82% of the variation, and all variables are highly statistically significant. The global factor is important in explaining the other 18% or in principle there is likely an effect of global demand on the US labor market or housing, but the bottom line is I don't think we can remove ourselves entirely from domestic supply-demand considerations. That said, I am not in Larry Summers's camp: I don't think he's fully appreciating how low the multiplier is on many of the spending items in the bill, and I also think it's crucial to point out that among those who have saved as a result of COVID, the savings is concentrated among those with high incomes; the bottom 40% of so have run negative saving rates since the beginning of COVID, so even the checks (which have the highest multipliers in the bill) are not for people already awash in cash, suggesting that people will use the money for paying down bills or keeping current on rent obligations, which of course is not inflationary.
Aged well
If I’m clear on my Kalecki, wasn’t it actually govt deficits that restored profits? Won’t we just see higher corporate profits from stimulus? If not, which Kalecki component will offset the greater govt dis-saving?
I think the surprise coming for MMT types may be that this spending push results in lower real wages and higher profits.
The MMT people don't have a theory of the inflation process. I have asked them about it. They said they are working on it. :))
In all fairness, no one really does. I think part of the problem is we are asking the word "inflation" to do too much. There are different types of price-change phenomenon that may have little to do with each other: 1) too much money chasing too few goods/overheating, 2) transient supply shocks/booms creating transient inflation (or disinflation), 3) loss of faith in the unit of account (e.g., USD), 4) asset price inflation.
When someone simply says "inflation" it means little to me.
I am persuaded of the opposite view. Inflation is above all a systemic phenomena. The paradigm of the Phillips curve is right. We just don't have the measure of slack appropriate for our more integrated world economy yet. In the post, I suggested one way we could go about constructing it.
(1) It's a common fallacy that 'inflation is always, everywhere a monetary phenomena'. In reality, money is created endogenously by the banks. That's not what causes inflation — inflation is completely independent of credit creation.
(2) Transient shocks can't do much. They dissipate away before having any impact on pricing decisions system-wide.
(3) There is no evidence of any loss of faith. To the contrary, the global financial system is plagued by a shortage of safe, public assets (T-bills) denominated in hard currencies.
Agree on 1 & 2 although these shocks can last a while and begin to feel like the “new normal”...it’s entirely possible things like shale oil and/or cheaper Chinese labor are transient.
As for 3, I think it’s complicated. What would be the signs and would it be too late by the time you saw them? It would be especially hard in a world where faith is being lost in all fiat since you may not get an FX signal. A boom in zero-duration, non-yielding assets could be one warning...or it could simply be a speculative boom. Is there any way to know? Another signal could be a sign that central banks are losing the ability (politically or otherwise) to tighten when needed - the jury is out I’d say.
What’s your story on the 1970s inflation?
You don’t address asset-price “inflation.” Is there no limit on wealth:GDP (especially in a world of low productivity and population growth)? Are there no long-term repercussions to “pulling forward” wealth via the discount rate? Strikes me there are potentially big consequences.
Like other frontier assets, Bitcoin is extremely high duration, not zero duration. The signal that makes sense to me is investors fleeing the obligations of the declining sovereign. That's very far from the case atm.
My understanding of the etiology of inflationary spiral of the 1970s is that expectations got de-anchored — same as the standard macro understanding. So I am with the doyens on keeping inflation expectations firmly anchored on target.
The relentless asset price booms that we've witnessed are driven by secular drivers, above all, the highly-advantageous balance of power between capital and labor, mediated by monetary policy ('wealth effect') and valuation cycles. We live in a 'good news is bad news' world, where the risk that the Fed would remove accommodation trumps the response of higher corporate earnings on asset prices.
There are definite long-term effects of «“pulling forward” wealth via the discount rate.» Above all, the secular decline in the neutral rate makes monetary policy entirely reliant on balance sheet management. So the impact of accommodation is felt most in asset valuations while there the effect on economic activity is very weak. But the central bankers don't know what else to do. They want the politicians to revive the fiscal toolkit. And that's what we're seeing finally with the Harris-Biden people.
So the big Q is when and how inflation expectations became de-anchored. Clearly we realized it too late in the 1970s. I feel like we're flying blind - we can look at the TIPS market but not much else. I have a suspicion that if TIPS were to signal de-anchoring (>3%?) we'd begin to "explain it away." We shall see.
I believe real wages fell in the 1970s so I have no idea where this "inflation is good for the working class" theory comes from. You haven't said that - but I hear it a lot, albeit slightly disguised.
Agree on how we got here with regards to asset prices. I fear we have essentially painted ourselves into a corner already. The "velocity of wealth" is currently very low. If it were to increase, the Fed essentially needs to run the process in reverse and destroy wealth to keep inflation in-check. I'm not sure that's possible as: 1) it will be politically unpopular among the powerful class, 2) it may lead to temporary falls in spending as people "freeze up" (and we essentially have a policy to short-circuit all such falls). A fiscal push may be exactly what tests this theory...
so you were completely wrong as of summer 2022
Nice write up. The global factor influencing inflation is under-appreciated, and I think you have a solid analytical way of showing it, so thank you for sharing.
That said, I'm not willing to totally toss domestic slack out of the window. Not sure how familiar you are with the SF Fed's decomposition of core PCE inflation into cyclical inflation vs. acyclical. Acyclical has been falling, likely due to technology and globalization. But the cyclical factor (which represents about 75% of the overall core PCE contribution) is still highly influenced by domestic factors. My favorite Phillips curve specification models cyclical inflation as a function of the unemployment gap (using CBO's estimate) and multifamily housing starts (relative to the population), along with a lag and a constant. Going back to 1985 this specification explains 82% of the variation, and all variables are highly statistically significant. The global factor is important in explaining the other 18% or in principle there is likely an effect of global demand on the US labor market or housing, but the bottom line is I don't think we can remove ourselves entirely from domestic supply-demand considerations. That said, I am not in Larry Summers's camp: I don't think he's fully appreciating how low the multiplier is on many of the spending items in the bill, and I also think it's crucial to point out that among those who have saved as a result of COVID, the savings is concentrated among those with high incomes; the bottom 40% of so have run negative saving rates since the beginning of COVID, so even the checks (which have the highest multipliers in the bill) are not for people already awash in cash, suggesting that people will use the money for paying down bills or keeping current on rent obligations, which of course is not inflationary.