One of the sentences I have most enjoyed reading and internalizing is this one, by Scott Sumner: Never Reason From A Price Change.
I’ve capitalized each word in that sentence because it really is a sentence that makes you think until your head hurts. Here’s an early (perhaps the first) blog post from Scott in which he explains what he’s getting at:
My suggestion is that people should never reason from a price change, but always start one step earlier—what caused the price to change. If oil prices fall because Saudi Arabia increases production, then that is bullish news. If oil prices fall because of falling AD in Europe, that might be expansionary for the US. But if oil prices are falling because the euro crisis is increasing the demand for dollars and lowering AD worldwide; confirmed by falls in commodity prices, US equity prices, and TIPS spreads, then that is bearish news.https://www.themoneyillusion.com/never-reason-from-a-price-change/
At its simplest – although there is always more to it than that – never reason from a price change means that the price might have changed because of demand, or supply or both. The headaches begin when you try to think through which of these might be more dominant, and the headache acquires splitting migraine status when you realize that you need to also ask about what else might be at play.
If you are a student of macroeconomics, a useful way to spend a morning is by clicking through this set of links and reading other posts by Scott Sumner on this topic. Remember, as always, the point is not to necessarily agree with Scott, but to read and ask how and why he arrives at his conclusions, and if you disagree with him, why do you do so. Best way to learn, especially if you can find a friend nerdy enough to do the exercise with you.
Which is a nice way to segue into our topic du jour: inflation.
A candy bar that cost a nickel in 1950 today costs $1.25 or so, depending on where you buy it. That, in a paper wrapper, is the price revolution of the twentieth century. Why did it happen? The answer usually given is that the quantity of money increased – too much paper money chasing too few candy bars.http://www.economicprincipals.com/issues/2022.05.01/2521.html
A more satisfying explanation, casual though it may be, is to recognize that the global economy has grown considerably more complex since 1950, and the system of money, banking, and credit more complex along with it. The price of the candy bar wasn’t going to return to its previous level, no matter what the Fed or the candy-manufacturers did.
So begins a lovely little ruminative essay by David Warsh on how to think about inflation. It is lovely, but the emphasis in the previous sentence should be on the word “little”. I wish it was ten times longer!
But students used to textbook definitions of inflation might have their curiosity piqued after reading the second paragraph from the extract: what might complexity have to do with inflation?
A somewhat cryptic answer is given in the very next line that follows the end of the extract, where David Warsh refers to a book he wrote in 1984, called The Idea of Economic Complexity. I haven’t read the book, but I remember being told about it – alas, I can no longer remember who recommended it to me! But the idea of the book, from what I can recollect of the discussion, is as follows:
If you were to manufacture a Nokia 3310 today, odds are that you would be able to manufacture it at a fraction of the price that it commanded when it was first launched. Duh, you might think: so far, so obvious. Warsh’s point in the book is that this doesn’t necessarily mean that phones have become cheaper. In fact, as we can all attest, they go up in terms of price every year. The exact same thing might become cheaper, sure, but we keep making stuff more complex as we go along, and it is this increasing complexity that adds to inflation.
Now, bear in mind that I am treading on extremely thin ice over here! I’m describing a book to you that I haven’t read (strike one), on the basis of a conversation about the book that took place many years ago (strike two), and I’m now about to speculate on what else might be at play where this idea is concerned (strike three!).
All those CYA disclaimers aside, I’d like to think that complexity need not be just about the product itself, but could also be about the way it is manufactured, where all it is manufactured, where it is assembled, and how it is sold. Not to mention how all of this is financed!
As I’ve said before on these pages, macro is hard!
In Economic Development and the Price Level, in 1962, Geoffrey Maynard argued the opposite: that money generally adjusts to trade, rather than trade to money. In very different formats, the argument continues today.http://www.economicprincipals.com/issues/2022.05.01/2521.html
“Development” is a bland word with which to describe the difference between the world economy in the time of Columbus and the world today. Economic philosopher David Ellerman has suggested that diversity describes the key difference, grounding his description in information theory; I proposed complexity in that 1984 book. But what is it that has become more diverse or complex? Not until I read “Increasing Returns an Economic Progress” (1928), by Allyn Young, did it occur to me that the growing complexity I had been thinking about were increases, of one sort or another, in the division of labor.
What a lovely excerpt, no? So much to add to the “To Read” list, but also how wonderful to pause and ponder on what the link might be between a Smithian division of labor and inflation. I hope you pause and think about this, much as I did when I read Warsh’s post, and again while drafting this paragraph right now.
To be clear: you’d expect division of labor to make systems more efficient, and therefore things cheaper. But Warsh suggests that there might be a way to link division of labor to complexity, and complexity to inflation!
Warsh ends his post in enigmatic fashion:
Are you comfortable with the too-much-money-chasing-too-few-goods story? Do you believe that the Fed could have prevented the rise in its price? And if wasn’t “inflation,” then what was it? The depreciation of money, relative to goods?http://www.economicprincipals.com/issues/2022.05.01/2521.html
As with the sixteenth-century voyages of discovery, money follows development and development follows money. If you have only the quantity theory of money to rely on, you don’t know what is going on.
And that, I’d argue, is A Good Thing. A Good Thing because it allows us to prioritize reading The Idea of Economic Complexity, and allows to think about what David Warsh might be hinting at. An incentive (a carrot) to read the book, in other words, and one that I plan to use in the coming weeks.