I’ve had a couple of readers and one ex-student challenge my thinking that deflation was more of a risk than hyper-inflation over the last couple of years and that loose monetary policy and “printing money” (more on that later) is not likely going to lead to massive inflation of everything and the debasement of hard currencies.
So let’s take a look at the thinking behind my views.
Core inflation is the one to be concerned about. This is the one that separates the trends from the volatile month to month and year to year changes in volatile commodity prices. It’s also the one that sets inflationary expectations of “sticky prices”. To prove the point, note that headline inflation recently was way below target for Europe and core inflation has been slowly declining along with the struggling economy and output gap. The stats just don’t support inflation.
This graph shows that inflation is, and remains, low. Exceptional recent periods are dramatic deflation rather than hyperinflation.
It is true that food and beverage inflation has spiked recently, but not out of line with past spikes. Food is a volatile item (and more on that later) so it’s hard to determine this as a trend yet. Even if it is a trend, there are real-world supply and demand issues that more than explain changes in food prices.
All items less food and energy, therefore the more stable items that generate sticky prices and inflation expectations show very low inflation.
This is why we should look at core inflation and not headline inflation. The following graph has been “lifted” from that blog post by economist Paul Krugman – read the entire post to understand his differentiation here between sticky and flexible prices.
The interesting point that comes from thinking about consumer inflation versus commodity inflation is how little of our food prices reflect commodity inputs. Labour, service, transport, processing and packaging are often more significant components of the cost of food rather than the raw materials.
The next point is that supply shortages (due to bad weather around the world) and demand increases (primarily China, for consumption but also stockpiling) are more than enough to explain the spike in commodity prices for wheat and others. I don’t have food price-elasticities at hand, but they are very very low. Small demand increases or supply shortages require huge price swings to balance quantity supplied and demanded.
Loose monetary policy always leads directly to inflation
The examples of Zimbabwe and Germany are held up to show how “printing money” leads to hyperinflation.
Those countries had economic situations different from the US / Europe at the moment. An asset bubble bursting, a huge recession leading to a liquidity trap and a huge output gap is the story of Japan from the 1990s and the US / Europe recently. Japan has had an exceptionally loose monetary policy, including effectively 0% interest rates and quantitative easing for decades since the 1990s.
Let’s look at that their “hyperinflation”
It’s very simply because of the liquidity trap and low inflation expectations (and lack of credibility of the Japanese government in injecting inflationary expectations into the economy) that their economy has stumbled along for decades with low inflation and low interest rates. This is not the result we want for the US or Europe.
I’ll be saying this again – some more inflation and higher inflationary expectations would be a good thing, not a bad thing.
I wish I had more time to cover other points (like how slowly actual money supply has been increasing compared to popular views, and how necessary stimulus still is) but it’s late.
Meanwhile, remember, slogans don’t explain economics. Just because you want to believe that low interest rates and “printing money” are evil, doesn’t make it so when you analyse with eyes wide open.