Yes, Inflation/Deflation is Hard to Measure

One of the hardest concepts for Principles students, politicians and pundits, oh heck, just about everyone to fully grasp is inflation.  A big part of the reason is because inflation is an abstract concept that is not directly measurable.  We can conceive of it, but we can’t measure it.  I’m no physicist (and open to correction) but it strikes me that it’s a bit on par with “momentum” or “latent energy” in physics.   We don’t have direct-measuring energy-o-meters.  We measure the effects and infer the energy.  Inflation is similar.  We can conceive of a generalized, across-the-economy, sustained trend pushing all/most prices upward such that the unit of money is losing real value in general terms.  Inflation is the sustained push behind all prices. We can’t measure that directly. But we can measure the effect it has: rising prices. The problem comes in that not all prices will be rising at the same time or by the same amount.  Further, during any time period, at least part of the change in price for any good is it’s change in real price relative to all other goods (supply and demand as taught in micro).

We try to deal with this measurement issue by creating a price index – an index that tracks the changes in shopping list of goods over time.  But any price index is a just a subset of all the prices.  Even the Billion Price Project index at MIT admittedly misses most services and lots of consumer goods that aren’t available online.  Price indices are very imperfect beasts.  They have many faults, not the least of them being that they often tend to be volatile in nature.  Since we’re looking for an estimate of inflation which means sustained increases, we need to massage the data further by creating some kind of “core inflation” measure or “trimmed means” type price index.  I’ll explain those some other time.

What prompted today’s post is an article in Bloomberg and a post by Krugman about it.  Together they illustrate one of the reasons so many people want to believe we have greater inflation than we really do.  Companies like to disguise price changes.  They don’t want to be known that prices could be cut in response to demand. Example: auto company offers $2000 rebate on $20,000 car but won’t cut price by 10%, or a firm offers a “value meal”, or they offer a freebie bundled product.  Similarly they often disguise price increases by reducing sizes or portions or by changing the financing.  From Krugman:

Good article in Bloomberg:

Procter & Gamble Co.’s failure to raise the price of Cascade dishwashing soap shows why investors are buying Treasuries at the lowest yields in history, giving the Federal Reserve more scope to boost the economy.

The world’s largest consumer-products company rolled back prices after an 8 percent increase lost the firm 7 percentage points of market share. Kimberly-Clark Corp. (KMB) started offering coupons on Huggies after resistance to the diapers’ cost. Darden Restaurants Inc. (DRI) raised prices at less than the inflation rate as patrons order more of Olive Garden’s discounted stuffed rigatoni than it anticipated.

This is basic economics; prices tend to fall, or at least slow their rise, when there is vast excess capacity and weak demand.

As both the article and Krugman’s excerpt show, we’re closer to deflation than most people realize.  They don’t see the failed attempts to raise prices.  They don’t see the shifts in portions or increase in coupons that reduce effective prices.  What they do see and remember is the $.50 increase in a loaf of bread or the $.70 increase in a gallon of gas.  But even with the gas, they selectively remember the $.70 price increase in summer, but forget the $.75 price drop in autumn.  Inflation and deflation are tricky things to measure.


Krugman Is Still Wrong About MMT – and with it still wrong on deficit

On Friday Paul Krugman posted the first of what has become 2-3 posts on his blog wherein he claims that MMT is “just wrong”.  As I noted Friday here, I commented on his blog to point out how his post was deceptive and misrepresented MMT.  I was not alone.  Well over 100 people have taken him task in his comments section for not having done his homework on MMT.

For those that want a more detailed refutation of the nonsense Krugman published, here’s a few links that have come up the last few days:

Bill Mitchell at Billyblog My favorite quote here:

Poor scholarship also involves not learning from your errors. You have often rightly accused the main body of our profession of having their heads in the sand (see How Did Economists Get It So Wrong?) and being inflexible in responding to the crisis.

Yet, you seem to keep wheeling the same errors of reasoning out yourself.

Scott Fulwiller writing at NakedCapitalism

The Daily Kos made three posts:

Paul Takes Another Swipe at MMT

Krugman Misleads His Readers – AGAIN!

The lesson, kids, is that even Nobel prize winners need to keep doing their homework.  If you are going to criticize some ideas, it is very important to actually read the stuff first.


Krugman on MMT

Paul Krugman comments today on Modern Monetary Theory (MMT).  Unfortunately, he gets it wrong.  For example, he says:

Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency.

I wish I could agree with that view — and it’s not a fight I especially want, since the clear and present policy danger is from the deficit peacocks of the right. But for the record, it’s just not right.

The key thing to remember is that current conditions — lots of excess capacity in the economy, and a liquidity trap in which short-term government debt carries a roughly zero interest rate — won’t always prevail. As long as those conditions DO prevail, it doesn’t matter how much the Fed increases the monetary base, and it therefore doesn’t matter how much of the deficit is monetized. But this too shall pass, and when it does, things will be very different.

I commented and posted this response to him on his blog:

Paul, you either have an incomplete understanding of MMT or have setup a strawman. MMT does NOT hold that “deficits never matter, as long as you have your own currency.” MMT says that deficits do matter but only if (a) there’s no slack of real resources in the economy and (b) the private sector is choosing to net accumulate debt instead of accumulate net financial assets. In the meantime, however, as long the private sector wants to accumulate net financial assets, deficits are necessary to prevent Aggregate demand from falling.

You apparently prefer to use the interest rate on safe assets as the indicator of whether there’s slack real resources available – hence your emphasis on liquidity trap lingo. MMT emphasizes actual unemployment. If there’s significant unemployment, then there’s slack resources available for the government to purchase and put to use producing incomes for people.

A key insight of MMT is how the real world of banking has changed since the 1970’s when gold and fixed rates were abandoned. In our real world today, reserves do not constrain bank lending and money creation. The fears of inflation based on old equation of exchange theories are unfounded. It’s a shortage of real resources that will drive inflation, not deficits per se.

I’m not the expert on MMT. I’m just a teaching economist with both a lot of teaching and practical applied experience. If you really want to know MMT from the experts, try folks like Bill Mitchell and his Billy Blog, or Randy Wray and company at New Economic Perspectives. For that matter, read Wray’s books or Mitchell’s books.


Shock Doctrine, Neo-liberalism, and Current Events

Primarily for my Comp Systems and Political Economy students (this is part one):

As previously noted here, the events in Madison, Wisconsin are not unique.  There appears to be a concerted effort to roll-back collective bargaining rights for many workers and roll-back social programs all because of a supposed  “fiscal crisis”- the idea that government budgets are out-of-control in spending.  Yet, this “fiscal crisis” is largely contrived and to the extent it exists at all, it is due not to increased spending but from reduced tax collections resulting from the Great Financial Crisis Wall St. created and repeated tax cuts, especially for the wealthy.

So what we have is a “crisis” that supposedly justifies drastic cut-backs in social support, increased privatization, and reduced tax burden on the wealthy.  If it sounds familiar, that’s because it is.  It sounds a lot like the way neo-liberal “global capitalism” was forced onto much of the world over the last 40 years.  Naomi Klein, in her book Shock Doctrine explains the strategy used, including the fact that leading neo-liberal ideologues (in the U.S. they are called “conservatives” or “libertarians” but not with much accuracy) intentionally do so.  They idea is to use any crisis, be it a natural disaster (Haiti earthquake?), or invasion (Iraq?), or revolution to force political economy changes that people might not otherwise accept.

Paul Krugman at the New York Times observes how the pattern is being applied here at home now in Wisconsin and other states:

Shock Doctrine, U.S.A.


Here’s a thought: maybe Madison, Wis., isn’t Cairo after all. Maybe it’s Baghdad — specifically, Baghdad in 2003, when the Bush administration put Iraq under the rule of officials chosen for loyalty and political reliability rather than experience and competence.

As many readers may recall, the results were spectacular — in a bad way. Instead of focusing on the urgent problems of a shattered economy and society, which would soon descend into a murderous civil war, those Bush appointees were obsessed with imposing a conservative ideological vision. Indeed, with looters still prowling the streets of Baghdad, L. Paul Bremer, the American viceroy, told a Washington Post reporter that one of his top priorities was to “corporatize and privatize state-owned enterprises” — Mr. Bremer’s words, not the reporter’s — and to “wean people from the idea the state supports everything.”

The story of the privatization-obsessed Coalition Provisional Authority was the centerpiece of Naomi Klein’s best-selling book “The Shock Doctrine,” which argued that it was part of a broader pattern. From Chile in the 1970s onward, she suggested, right-wing ideologues have exploited crises to push through an agenda that has nothing to do with resolving those crises, and everything to do with imposing their vision of a harsher, more unequal, less democratic society.

Which brings us to Wisconsin 2011, where the shock doctrine is on full display.

In recent weeks, Madison has been the scene of large demonstrations against the governor’s budget bill, which would deny collective-bargaining rights to public-sector workers. Gov. Scott Walker claims that he needs to pass his bill to deal with the state’s fiscal problems. But his attack on unions has nothing to do with the budget. In fact, those unions have already indicated their willingness to make substantial financial concessions — an offer the governor has rejected.

What’s happening in Wisconsin is, instead, a power grab — an attempt to exploit the fiscal crisis to destroy the last major counterweight to the political power of corporations and the wealthy. And the power grab goes beyond union-busting. The bill in question is 144 pages long, and there are some extraordinary things hidden deep inside.

For example, the bill includes language that would allow officials appointed by the governor to make sweeping cuts in health coverage for low-income families without having to go through the normal legislative process.

And then there’s this: “Notwithstanding ss. 13.48 (14) (am) and 16.705 (1), the department may sell any state-owned heating, cooling, and power plant or may contract with a private entity for the operation of any such plant, with or without solicitation of bids, for any amount that the department determines to be in the best interest of the state. Notwithstanding ss. 196.49 and 196.80, no approval or certification of the public service commission is necessary for a public utility to purchase, or contract for the operation of, such a plant, and any such purchase is considered to be in the public interest and to comply with the criteria for certification of a project under s. 196.49 (3) (b).”

What’s that about? The state of Wisconsin owns a number of plants supplying heating, cooling, and electricity to state-run facilities (like the University of Wisconsin). The language in the budget bill would, in effect, let the governor privatize any or all of these facilities at whim. Not only that, he could sell them, without taking bids, to anyone he chooses. And note that any such sale would, by definition, be “considered to be in the public interest.”

If this sounds to you like a perfect setup for cronyism and profiteering — remember those missing billions in Iraq? — you’re not alone. Indeed, there are enough suspicious minds out there that Koch Industries, owned by the billionaire brothers who are playing such a large role in Mr. Walker’s anti-union push, felt compelled to issue a denial that it’s interested in purchasing any of those power plants. Are you reassured?

The good news from Wisconsin is that the upsurge of public outrage — aided by the maneuvering of Democrats in the State Senate, who absented themselves to deny Republicans a quorum — has slowed the bum’s rush. If Mr. Walker’s plan was to push his bill through before anyone had a chance to realize his true goals, that plan has been foiled. And events in Wisconsin may have given pause to other Republican governors, who seem to be backing off similar moves.

But don’t expect either Mr. Walker or the rest of his party to change those goals. Union-busting and privatization remain G.O.P. priorities, and the party will continue its efforts to smuggle those priorities through in the name of balanced budgets.

Leadership FAIL: Again

This time I’ll outsource the job to Paul Krugman at the New York Times.  I don’t always agree with Paul, but he’s spot on with this. The Obama administration never misses an opportunity to miss an opportunity, especially if it involves banks.

Epitaph For An Administration

In today’s report on the foreclosure mess, a revealing sentence:

As the foreclosure abuses have come to light, the Obama administration has resisted calls for a more forceful response, worried that added pressure might spook the banks and hobble the broader economy.

Surely this can serve as a generic statement:

As NAME ISSUE HERE has come to light, the Obama administration has resisted calls for a more forceful response, worried that added pressure might spook the banks and hobble the broader economy.

Stimulus, bank rescue, China, foreclosure; it applies all along. At each point there were arguments for not acting; but the cumulative effect has been drift, and a looming catastrophe in the midterms.

Or to put it another way, the administration has never missed an opportunity to miss an opportunity. And soon there won’t be any more opportunities to miss.


Krugman on How Did Economists Get It So Wrong? – Excellent

Long, but excellent reading on the recent (last few decades) of the history of macro thinking.  I think Krugman understates some issues, but much of it is good.  I recommend.

It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession. On the theoretical side, they thought that they had resolved their internal disputes. Thus, in a 2008 paper titled “The State of Macro” (that is, macroeconomics, the study of big-picture issues like recessions), Olivier Blanchard of M.I.T., now the chief economist at the International Monetary Fund, declared that “the state of macro is good.” The battles of yesteryear, he said, were over, and there had been a “broad convergence of vision.” And in the real world, economists believed they had things under control: the “central problem of depression-prevention has been solved,” declared Robert Lucas of the University of Chicago in his 2003 presidential address to the American Economic Association. In 2004, Ben Bernanke, a former Princeton professor who is now the chairman of the Federal Reserve Board, celebrated the Great Moderation in economic performance over the previous two decades, which he attributed in part to improved economic policy making.

Last year, everything came apart.

For the complete article, see:

Krugman’s article caused quite a stir in academic and professional economics.  Many have agreed with him, such as Jeff Frankel who posted this:

The Queen of England during the summer asked economists why no one had predicted the credit crunch and recession.   Paul Krugman points out that, inasmuch as economists can almost never predict the timing of recessions (and don’t claim to be able to), the real questions are worse.  The real questions are, rather how macroeconomists (most of us) could have gotten it so wrong as to believe that: (i) a severe recession like this was not even looming ahead as a danger, and (ii) a breakdown of many of the world’s most liquid financial markets, in New York and London, was not possible.To anyone wondering about these questions, I recommend Krugman’s essay in the New York Times Sunday magazine, September 6:  “How Did Economists Get it So Wrong?” . I think he has it exactly right.

I would only add that he is modest in skipping over one point:  during Japan’s lost decade of growth in the 1990s Paul forcefully drew from the Japanese experience the implication that a severe economic breakdown was, after all, possible in a modern industrialized economy – a breakdown that both was reminiscent of the Great Depression and was outside the ken of modern macroeconomic theory.   But macroeconomics went on as before.   (Likewise with the stock market correction of 1987, the LTCM crisis of 1998, and the dotcom bust of 2000-01.   I do think, however, that our field did a better job with the emerging market crises of 1994-2001, in part because it was considered permissible to argue that financial markets in this case were highly imperfect.)

Even the cartoons in the NYT article are good…  except that I have never seen Olivier Blanchard in a double-breasted suit.    But Robert Lucas definitely merits a place there:   when given one page to defend orthodox economists regarding the crisis in a recent  Economist essay, he actually thought it was a useful rebuttal to point out that critics are repeating arguments they have made before.  And he also thought it was useful to explain: “The term “efficient” as used here means that individuals use information in their own private interest. It has nothing to do with socially desirable pricing; people often confuse the two.”  — as if it is not the latter question that the public is wondering about.

I am pleased that at least some in the profession are waking to the serious methodological and intellectual problems that have crept into economics (not just macro) in recent decades.  There’s a long way to go though before we return to math only being a tool to check/explore the logic instead of the centerpiece.  We need to put real-world economies back in focus as the topic of our theorizing and research.