Paul Krugman responds (and also visit his Twitter profile to take a look at other threads by him on the issue).
But above all: if you think macro is tough, the good news is that you’re in excellent company!
Paul Krugman responds (and also visit his Twitter profile to take a look at other threads by him on the issue).
But above all: if you think macro is tough, the good news is that you’re in excellent company!
You can hardly read a news source these days without reading one article or the other about inflation. There’s plain vanilla inflation, there’s shrinkflation, and there’s skimpflation. There is, one might argue, an inflationary spiral in coining terms related to inflation!
But as students of economics, I found a recent blogpost written by Virginia Postrel quite fascinating. She speaks about inflation being a formative experience as a young person growing up in the 70’s, and for this blog post, she asked some folks who were around then to speak of their memories regarding the inflation episodes of the 1970’s.
And what made this such an enjoyable read is the fact that day to day activities and behaviors changed due to inflation. It’s one thing to speak about how prices went up, and households cut back on their expenditures. But it is quite another to speak about how the lives of ordinary people changed as a consequence of inflation:
In the late 1970s, Tom Noonan, then around 20 years old, worked in a Winn-Dixie supermarket in Louisville, Kentucky. His job was to change price tags a couple of times a week. He’d go through the store with a box cutter and a pricing gun, slicing off the old price stickers and applying the new, higher ones. It’s one of the 1970s memories that came pouring out of my Facebook friends when I asked about their experiences.https://vpostrel.substack.com/p/from-the-archives-remembering-inflation
Not every store was so meticulous. Many just slapped the new prices on top of the old ones. “I half remember peeling off price labels to get a lower price (maybe on a book?), not even realizing that what I was doing was wrong or illegitimate,” confesses Mike Schiffer, a law school IT manager born in 1968, in the Facebook thread. “I don’t think I really understood how prices were set or changed at that point.”
Which activities, tasks and chores have changed in our lives today because of the recent bout of inflation? How does inflation manifest itself in terms of how we lead our day-to-day lives? With barcode scanners, Tom Noonan’s job no longer need exist in most (but not all!) cases, and that is a good example of how you might want to think about the intersection of inflation, technology and day to day lives.
And if you’ll allow me a brief but entertaining digression: this would also be a good time to talk about, well, barcodes:
How vast mega-stores emerged with the help of a design originally drawn in the sand in 1948 by Joseph Woodland as he sat on a Florida beach, observing the furrows left behind, an idea came to him which would – eventually – become the barcode. This now ubiquitous stamp, found on virtually every product, was designed to make it easier for retailers to automate the process of recording sales. But, as Tim Harford explains, its impact would prove to be far greater than that. The barcode changed the balance of power between large and small retailers.https://www.bbc.co.uk/programmes/p04k0066
Not just this episode – please listen to the entire series, and purchase the book if you can. This series remains a great way to understand how our day to day lives in the modern economy are impacted in surprising ways by inventions we take for granted. Such as the barcode, for one – but on an entirely related note, also check out the episode on shipping containers:
How a simple steel box changed the face of global trade. Shipping goods around the world was – for many centuries – expensive, risky and time-consuming. But 60 years ago the trucking entrepreneur Malcolm McLean changed all that by selling the idea of container shipping to the US military. Against huge odds he managed to turn “containerisation” from a seemingly impractical idea into a massive industry – one that slashed the cost of transporting goods internationally and provoked a boom in global trade. Tim Harford tells the remarkable story of the shipping container.https://www.bbc.co.uk/programmes/b08jbd20
Both, of course, have a lot to do with inflation today – and both are not objects that would come up in an introductory course on economics, more’s the pity.
But a useful question to think about as a student of economics today is this: which of our day to day activities today are impacted by inflation in surprising and unexpected ways? Or put another way, what would be a good Tom Noonan example from today?
Thinking about this question is a good way to think about economics, but even better, economics in conjunction with technology and better-est of all, it helps you become a keener observer of life around you. An economic naturalist, if you will.
By the way, he is worth following on Twitter, and you might want to sign up for his newsletter too.
There’s learning macroeconomic theory, and there’s applying what you know to the world around you. In an excellent column, which we shall parse together, Neelkanth Mishra teaches us how to use basic micro and macroeconomics to make sense of the world around us.
He begins with an analogy of the spectrometer, a device used to ‘disentangle’ waves. Having explained what a spectrometer is, and what it might be used for, he then goes on to say that you might be able to do something similar with economic phenomena, and asks if you could use an idea analogous to the spectrometer to disentangle the phenomena that are causing inflation.
Let’s dig in.
In theory, inflation is a macroeconomic phenomenon, and analysing it by category is unwise, as prices shift both supply and demand between categories — sometimes global and local factors mix as well. For example, higher oilseed prices could shift acreage from pulses in the upcoming Indian kharif crop, pushing up prices of pulses even though the initial supply disruption was in Ukrainian sunflower oil.https://tessellatum.in/?p=433
It’s one thing to learn about supply and demand. It is quite another to learn about partial equilibrium. But it is a whole other thing (and the point of the entire exercise) to be able to apply these ideas to what we see around us. Can higher oilseed prices cause an increase in the price of pulses? And even if you were to tentatively say ‘yes’, the real challenge would be the follow-up question: through what channels, and why?
He identifies two clear strands of driving factors that are responsible for inflation today, beginning with a larger than necessary stimulus applied in America during Covid-19. As an interesting aside, he says that this ended up pushing retails sales ten standard deviations above normal.
If you are a student reading this, take the time to pause over here and reflect on this statistic. Ten standard deviations above normal? That sounds like a lot! But you should also ask yourself the following:
The downward lash of this bullwhip is now starting, which can push apparent demand well below real demand. US federal fiscal deficit as a share of gross domestic product or GDP in the last three months is the lowest since June 2019. As services restart, a goods-to-services switch in consumption is underway; shipping bottlenecks have eased (though not fully); global industrial production got back above trend in February (though recent lockdowns in China hurt); and there is evidence of excessive inventory in many supply chains. Prices of TV panels and memory chips are falling, and the year-on-year price increases in metals are now much below those seen in April. Prices may not go back to the pre-Covid levels (meaning deflation from here), but the inflationary impulse does seem to be behind us.https://tessellatum.in/?p=433
The second global impulse, the start of the Russia-Ukraine conflict, may be harder to adjust to, with demand and supply adjustments likely to take many quarters. The conflict and the associated sanctions have reduced the global supply of food and energy. Given that global GDP growth and the use of dense energy are intimately linked, fiscal and monetary measures can only redistribute what remains between countries; they cannot offset the shortages. Nearly every major economy has announced energy subsidies — while this is understandable, given the domestic political compulsions as well as the need to sustain growth, they will only prolong the period of higher energy prices. This can be seen as countries competing for the remaining supplies of energy, pushing up prices until the weak hands (countries) give up. Higher prices have also not triggered investments in new supplies yet, as suppliers lack certainty on how long the shortages may persist. These trends could keep prices higher for longer than currently anticipated.https://tessellatum.in/?p=433
Moving to local drivers of inflation: Inflation occurs when a stimulus pushes aggregate demand above the economy’s capacity to meet it. Even though state governments’ deficits are much lower than budgeted, the total government deficit in India is higher than in pre-Covid times. The recent fiscal steps to prevent a rise in fertiliser and fuel prices, while prudent and to some extent necessary, may serve only to spread inflation over a longer period. The rise in India’s current account deficit (CAD), with May balance-of-payments (BoP) deficit run-rate at nearly 2 per cent of GDP, also suggests domestic demand, at least in its current mix, is unsustainable.https://tessellatum.in/?p=433
If I was conducting an interview for a student who was aspiring to join the corporate world as an economist, I would have liked to have shown the candidate this paragraph, given them a laptop with an internet connection, and told them that they have thirty minutes to find the answers to the following questions:
If you are not able to answer these questions, and you are currently a student of macroeconomics, you might wish to add stuff outside of your textbooks into your diet.
But now, best of all, for the three paragraphs that follow the one that I quoted in the previous section, I won’t come up with a list of comments and questions. I’ll in fact ask you to come up with questions yourself, along the lines that I just did, and then see if you can answer them.
Go ahead, give it a try!
This article is a great example of what hands on macroeconomics looks like. If you are in college and are wondering what your syllabus has to do with the world outside, ask yourself a simple question: do you see yourself as being capable of writing a similar article yourself?
That, if you ask me, is a true examination. Write it, please, and share it with all of us by putting it up for us to read in the public domain. What a great addition to your CV that would be.
Soon after I started blogging, Tyler Cowen joked, “You’re not really a blogger.” His point: Unlike most of the competition, I wasn’t reacting to the latest news or whatever’s hot. My goal as a blogger has always been to write think-pieces that stand the test of time.https://www.econlib.org/a-fond-farewell-to-econlog/
I don’t know about standing the test of time where posts on EFE are concerned, but my approach to blogging is very similar: I prefer to not write about events immediately after they’ve occurred. This for a variety of reasons, not least of which is the fact that I’m lazy, and reading a lot of stuff at very short notice is something I would rather not do.
Another reason is that the very best pieces on any event usually take time to bubble up in my feed, and waiting therefore makes sense.
By the way, if you aren’t yet subscribed to Bryan Caplan’s new blog, please do!
But that being said, let’s talk about yesterday’s rate hike.
One of the pieces that I enjoyed writing last year was on the concept of meta-epistemology, after reading a post about it by Zeynep Tufekci.
I’m going to post a screenshot rather than an extract, because the formatting of the post helps:
Honest question: does this apply to the Reserve Bank of India as well?
Is it the case that the cost of downplaying inflation as a major problem now exceed the benefits of doing so? Have the incentives flipped for the RBI? If so, on what basis? Is there a sense, based on preliminary data, that inflation is a problem that can no longer be ignored?
And if so, how should we be interpreting not just the fact that rates have been raised, but the manner and the timing of the raise? In other words, are there two messages being sent out by the RBI: the message itself, and the implicit message encoded in the timing of the message?
And have (or will) the markets internalize this message, and if yes, what is to follow?
Learning about inflation, monetary policy, and the efficient market hypothesis via textbooks is less than half of the story. Take your view/model of how the world works to the world itself, and update your model as the years roll by.
Fun, exhilarating and occasionally nerve-wracking.
But it is the best way to learn.
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.
If you are an undergrad or post-grad student in India studying economics, you’ve no doubt been taught how to think about GDP (ways to measure it, ways to define it, its limitations, its advantages). But if you ask me, what we fail to do enough of is explain to students how one is supposed to use these concepts.
I often tell my students that GDP for a nation is like grades/marks obtained by a student. In much the same way that grades are not an accurate reflection of all of what a student has done in an academic year (even in purely an academic sense), GDP isn’t an accurate reflection of what a country has earned in a given time period. But also in much the same way that we have not been able to come up with a better way to assess students, we have not been able to come up with a better way to measure the economic output of a nation.
So while keeping in mind the fact that the measure isn’t perfect, but also that there isn’t a better measure in place just yet, let’s go ahead and read V Ananta Nageswaran’s excellent column in the Livemint about India and China’s medium term forecasts by the IMF.
What I am going to do below is highlight some sentences from this column and pose questions on the basis of these excerpts. Try and answer these questions, especially if you have been taught macro in your college/university. To my mind, this will go a very long way towards helping you understand if you have, well, understood key macroeconomic concepts:
I’d recommend that you try and figure out the answers to these questions yourself, or even better, with a group of like-minded people. Run them past your prof(s), and see what they have to say. Wwrite up/record your answers and put ’em up for public consumption.
And best of all, try to come up with more such questions yourselves!
A student messaged last week, asking some questions about inflation and its measurement in India. In particular, they wanted to know about food and its impact on inflation right now.
Well, outsourcing is always and everywhere a good idea, and Vivek Kaul had already answered the question at great length:
What this means is that, despite the end consumers of food paying a higher price, the farmers are largely not benefitting from this rise in food prices, given that they sell their produce at the wholesale level.https://vivekkaul.com/2020/10/13/10-things-you-need-to-know-about-indias-high-inflation/
This difference can be because of a few reasons.
a) A collapse in supply chains has led to what is being sold at the wholesale level not reaching the consumers at the retail level, thus, leading to higher prices for the consumer.
b) This could also mean those running the supply chains hoarding stuff, in order to increase their profit.
Having said that, the former reason makes more sense given that stuff like vegetables, egg, fish and meat, etc., cannot really be hoarded. Also, hoarding stuff like pulses, needs a specialized storage environment which India largely lacks.
The entire article is worth reading (and so is subscribing to Vivek’s blog, so please do so!). And if you think 2020 isn’t depressing enough already, do read this article, also written by him. A short excerpt follows:
To conclude, the Indian economy will contract during the second half of the financial year. There is a slim chance of growth being flat for the period January to March 2021. Inflation, even though it might come down a little, is likely to remain high due to the spread of the covid pandemic. Hence, India will see conflation through 2020-21.https://vivekkaul.com/2020/09/15/conflation-contraction-inflation-is-here-and-it-will-stay-this-year/
From a reading-the-tea-leaves perspective, it would seem the RBI actually isn’t that worried about inflation right now (and rightly so!). Here’s an excerpt from an excellent newsletter, Anticipating the Unanticipated that makes this point:
But the RBI wants to signal it is willing to live with inflation running above ‘comfortable’ level in the coming days. The MPC report last week claimed almost 80 per cent of the increase in inflation beyond the 4 per cent target can be attributed to supply chain disruptions and increase in fuel prices. This it believes is a short-term phenomenon and inflation will be in the 5 per cent range next year. This is underlined to give comfort to bond investors to buy government securities without the fear of a near-term interest rate hike to contain inflation. Further, the other step announced by RBI in extending the HTM (hold-to-maturity) limits by another year to March 2022 is to protect any bondholder from the volatility of prices and booking losses on account of it. The overall RBI signal is it doesn’t want the worry of rising inflation and a consequent rate increase to come in the way of growth. It’s focus now is on improving the transmission of rate cuts to the borrowers to stimulate growth.https://publicpolicy.substack.com/p/77-the-inflation-conundrum-
… and here is Anantha Nageswaran making the same point, but by utilizing a different analysis:
This exercise generates the hypothesis that there is little or no intersection of the household inflation expectations formation and the monetary policy regime. Two, high inflation expectations peaked in September 2014. Similarly, the current high inflation expectations should peak as supply disruptions ease. So, in my view, RBI is betting correctly that the rate of inflation would ease and project policy on hold for the next few quarters. Three, inflation generation process should matter only to the extent that it affects medium-term output and employment generation. For now, other indicators suggest that it is not as disruptive as it was in 2011-13. Therefore, there is no need to turn it into a fetish. The new MPC and the central bank have done well and done good. They should be pleased.https://thegoldstandardsite.wordpress.com/2020/10/14/the-inexplicable-16-inflation-rate/
And for the data nerds among you, here is the Inflation Expectations Survey of Households by the RBI (do keep in mind the point Ananta Nageswaran makes about trimmed means in his article). Note that currently at least, not too many people seem to be too worried about persistently high food inflation.
Side note: Jason Furman’s podcast with Tyler Cowen contained this interesting snippet:
FURMAN: GDP could be more meaningful if we measured it better. The inflation rate gets harder and harder to measure over time. So I think the one that probably has deteriorated in meaningfulness is the measure of inflation. Number one, we don’t measure it well, and number two, it’s low enough that it’s hard to get that excited about it.https://medium.com/conversations-with-tyler/jason-furman-tyler-cowen-economics-b3e6d73dfd0f
COWEN: Is that a quality-of-goods problem? Or how we do chaining over time? Where are we going wrong in measuring inflation?
FURMAN: Just more and more of the economy is in areas that are harder to measure the quality of, healthcare being the most notorious.
I’ve said it before, and I’ll say it again: macro is hard.
Finally, here are past EFE articles on inflation.
As a student of economics, I think I’ve read one article too many on Germany’s inflation. In fact, one of the many joys of writing this blog has been discovering how bad inflation was in other parts of the world: the version of economic history that I have studied has underplayed this.
(Name four countries that experienced hyperinflation: Germany! Zimbabwe! Venezuela! Uhhhhhh…..)
But that being said, learning more about Germany this month wouldn’t be complete without at least one article about it’s hyperinflation. And the reason I enjoyed the one I excerpt from below is because while it is full of interesting anecdotes about the period of hyperinflation, it also speaks about how it all ended – and with what consequences. And a fun fact which you may have not known earlier: the root of the word credit means to believe. That’s modern finance, in a nutshell.
Obviously, though the currency was worthless, Germany was still a rich country — with mines, farms, factories, forests. The backing for the Rentenmark was mortgages on the land and bonds on the factories, but that backing was a fiction; the factories and land couldn’t be turned into cash or used abroad. Nine zeros were struck from the currency; that is, one Rentenmark was equal to one billion old Marks. The Germans wanted desperately to believe in the Rentenmark, and so they did. “I remember,” said one Frau Barten of East Prussia, “the feeling of having just one Rentenmark to spend. I bought a small tin bread bin. Just to buy something that had a price tag for one Mark was so exciting.”
All money is a matter of belief. Credit derives from Latin, credere, “to believe.” Belief was there, the factories functioned, the farmers delivered their produce. The Central Bank kept the belief alive when it would not let even the government borrow further.
The political “give” that was needed to get the political, economic, cultural and civilizational “take”, in an interesting article from DW. The set of links at the bottom of this article are also worth a read. (Note that I have added the WIkipedia link to the 2 Plus 4 Agreement, it is not there in the original).
The 2 plus 4 Agreement, also called the Treaty on the Final Settlement with Respect to Germany, recognized all European borders established after World War II, resolving this outstanding dispute once and for all. Bonn and Berlin’s signatures to the treaty meant that a newly reunited Germany would recognize national borders as they stood, not as they once were. Coupled with the reduction in military concentrations, the acceptance of current borders was a significant step toward an enduring peace in Europe at large.
An unusually short excerpt by my own standards, but this is the last sentence in the Wikipedia article about German reunification. It deserves to be read in the full, the entire article, especially if you were under the impression that reunification in Germany was relatively quick, painless and that there was much happiness all round.
The absorption of eastern Germany, and the methods by which it had been accomplished, had exacted a high price throughout all of Germany.
But there is an argument to be made that it was worth it, because one way of thinking about it is this: West Germany purchased access to culture by sharing economic prosperity, while East Germany purchased access to economic propserity by sharing culture. Costs matter, but maybe, just maybe, culture trumps economics?
“On average, people in the East are less successful, less productive and not as wealthy. Materially speaking, they’re less happy,” Seemann said. “But that’s exactly why cultural diversity in the eastern states plays a more important role than in the West. People in eastern Germany are aware that there are things which are more important than making money and paying taxes. They see the arts as a creative process of ‘togetherness.’ We need to strengthen this consciousness, because that’s the only way to ensure culture and society continues to thrive — regardless of where we stand economically in the years to come.”
Note that there are links at the bottom of this article about whether lessons from German reunification can apply to Korea. Alas, the article says no. I am an Indian, so double the alas for me, please.
And finally, a reminder that these things take time! This article is about the reunification of not Germany, but of the German language. Note that the East Germans had to adapt, and not the other way around. Maybe, just maybe, economics trumps culture?
The former East and West Germany have grown closer together in many areas over the past 26 years. At the same time, some differences are still marked precisely by the former border between East and West, such as economic strength, family structure and wealth. Furthermore, stereotypes about Wessis and Ossis have still not been consigned to history. According to a study carried out by the Berlin Institute for Population and Development, it will take another generation before German unity is firmly anchored in people’s minds. It has, however, long been reflected in the way they speak.