The Language of Inflation

[JEast]

I recently read a very good article on how hard it is to get your arms around a particular subject if you do not have the correct descriptive language of the subject or phenomenon at hand.  Case in point presently is that we have little in the way to describe the new global macro policies except that it is big and we have never gone down this path before.

 

In Edelweiss Journal's November 4th issue, author Dylan Grice makes the case that we have inadequate language to describe inflation.  To paraphrase the first paragraph,

“as for the economy, we know only this: it is a complex adaptive system.  From these observations can be derived a straightforward corollary on economic policy makers: trying to control a variable you can not measure (inflation) with a tool you do not fully understand (money) in a complex system with hidden, unobservable and non-linear interrelationships (the economy) is a guaranteed way to ensure that most things which happen were not supposed to happen.”

 

Maybe our (my) true lack of descriptive terms is why it is so confusing to even determine the correct sign (plus or minus) of a single output, namely inflation.

 

http://www.edelweissjournal.com

No charge for access.

 

 

Cheers

JEast

[rkbabang]

This is why I like the definition of inflation as the increase in the money supply.  That is something that can be measured, known, and agreed upon.  It is impossible to quantify the "rise in prices".  It just begs the question "the price of what?".  Prices of somethings will always be decreasing and prices of other things will be increasing.  The price of an item depends on so many other things other than the amount of money in circulation, that it is impossible to calculate the component of the price due to the money supply and not due to changes is supply, demand, quality, technology, availability of components needed for manufacture, weather, transportation, competing products, and a million other variables.  I'm not sure how valuable doing a "CPI" calculation is, because this calculation is dependent on which goods go into the basket and which goods are excluded. And once you do the calculation, it can't be known which variables are responsible for the change in price.  So when you have this number, what do you really know?

[Palantir]

Except that the "increase in money supply" is a cause of inflation, not inflation itself. Inflation really is about a general rise in price levels.

[zarley]

This is why I like the definition of inflation as the increase in the money supply.  That is something that can be measured, known, and agreed upon.  It is impossible to quantify the "rise in prices".  It just begs the question "the price of what?".  Prices of somethings will always be decreasing and prices of other things will be increasing.  The price of an item depends on so many other things other than the amount of money in circulation, that it is impossible to calculate the component of the price due to the money supply and not due to changes is supply, demand, quality, technology, availability of components needed for manufacture, weather, transportation, competing products, and a million other variables.  I'm not sure how valuable doing a "CPI" calculation is, because this calculation is dependent on which goods go into the basket and which goods are excluded. And once you do the calculation, it can't be known which variables are responsible for the change in price.  So when you have this number, what do you really know?

 

This is the reason why there is so much confusion.  A small group of people have decided to replace the generally accepted definition of a term 'inflation - a general rise in prices in an economy' with their own meaning 'inflation - an increase in the money supply.' 

 

Instead of just using a term like money expansion, they have co-opted a term with an accepted meaning and muddied the waters.  If I were less charitable, I'd propose that this confusion is intentional so as to sell things like gold and gold funds and to maintain a level of fear in segments of the population when actual economic outcomes aren't what you expected.

 

Is a general rise in the price level hard to measure with precision?  Sure.  But, CPI and the billion price project do a reasonable job of determining if there is a prevailing, general increase in prices.  Sure, everyone's consumption patterns are different, so increases in one sector might effect me differently than anyone else, but that's immaterial to the notion of a high-level movement of prices over time. 

 

Is there significant inflation in the US economy at the moment?  No, not really.  Has there been a broad-based decline in purchasing power over the last 3-5 years?  Not really.  I haven't seen it.  My cost of health care has gone up.  my cost of housing has gone down considerably.  Food costs are up in spots, but not egregiously so across the board. 

 

An expanding money supply isn't inflation if the velocity of money is declining.

[Palantir]

  If I were less charitable, I'd propose that this confusion is intentional so as to sell things like gold and gold funds and to maintain a level of fear in segments of the population when actual economic outcomes aren't what you expected.

 

Is there significant inflation in the US economy at the moment?  No, not really.  Has there been a broad-based decline in purchasing power over the last 3-5 years?  Not really.  I haven't seen it.  My cost of health care has gone up.  my cost of housing has gone down considerably.  Food costs are up in spots, but not egregiously so across the board. 

 

I agree with everything you said. Regarding the bolded, I agree there are vested interests in selling gold investment products, but I think that is secondary to this criticism being 100% politically motivated - the usual "Evil government (and Obama) is debasing the dollar and inflating us into poverty!".

[rkbabang]

  If I were less charitable, I'd propose that this confusion is intentional so as to sell things like gold and gold funds and to maintain a level of fear in segments of the population when actual economic outcomes aren't what you expected.

 

Is there significant inflation in the US economy at the moment?  No, not really.  Has there been a broad-based decline in purchasing power over the last 3-5 years?  Not really.  I haven't seen it.  My cost of health care has gone up.  my cost of housing has gone down considerably.  Food costs are up in spots, but not egregiously so across the board. 

 

I agree with everything you said. Regarding the bolded, I agree there are vested interests in selling gold investment products, but I think that is secondary to this criticism being 100% politically motivated - the usual "Evil government (and Obama) is debasing the dollar and inflating us into poverty!".

 

There are two sides to this, of course.  Obama probably knows less about inflation than we do or the people you are talking about.  Like all presidents he's basically a figurehead to look good in front of a camera and say a lot of nothings to the public.  The point Zarley made about the velocity of money is a good one.  The fact is that having a huge increase in the amount of money available means that the potential for the velocity to rapidly increase is now there.  The effects on prices don't have to be (and usually aren't) immediate and aren't always obvious (for example in an otherwise deflationary environment).  Imagine a company issuing a significant number of shares to grant to management. If the stock is still increasing in value that doesn't mean the issuing of those shares had no effect on the price.  The other side of the spectrum from the gold bugs and the Obama is evil crowd are the people who believe that those in charge of the money supply are omniscience with a superhuman ability to manage a system with trillions of variables, where in reality such a system is impossible for anyone to manage and any messing around with the inputs to such a system that does occur will have unpredictable results in the long run.  This is something which this crowd refuses to admit or believe.

[zarley]

  If I were less charitable, I'd propose that this confusion is intentional so as to sell things like gold and gold funds and to maintain a level of fear in segments of the population when actual economic outcomes aren't what you expected.

 

Is there significant inflation in the US economy at the moment?  No, not really.  Has there been a broad-based decline in purchasing power over the last 3-5 years?  Not really.  I haven't seen it.  My cost of health care has gone up.  my cost of housing has gone down considerably.  Food costs are up in spots, but not egregiously so across the board. 

 

I agree with everything you said. Regarding the bolded, I agree there are vested interests in selling gold investment products, but I think that is secondary to this criticism being 100% politically motivated - the usual "Evil government (and Obama) is debasing the dollar and inflating us into poverty!".

 

I tend to agree with that as well.  That's the bit about fear in my post.

 

You and I hold what I would consider the conventional view of inflation.  We probably won't disagree much on this particular issue. 

 

I think another way to put the conventional view would be to compare monetary easing to potential energy.  Money growth isn't inflation, but it does provide some of the raw materials for inflation in the future.  So, we can't dismiss the risks of inflation inherent in the system, but that is not the same as actually experiencing inflation.  A drawn bow has potential energy, which can be released in the firing of an arrow at high speed.  But, that is not the only possible outcome.  The archer can relax his bow in a controlled manner, resulting in no fired arrow at all.  So, standing in front of an archer with a drawn bow is not the same as actually being shot with an arrow.  Even so, it's not a great place to stand.

[rkbabang]

I tend to agree with that as well.  That's the bit about fear in my post.

 

You and I hold what I would consider the conventional view of inflation.  We probably won't disagree much on this particular issue. 

 

I think another way to put the conventional view would be to compare monetary easing to potential energy.  Money growth isn't inflation, but it does provide some of the raw materials for inflation in the future.  So, we can't dismiss the risks of inflation inherent in the system, but that is not the same as actually experiencing inflation.  A drawn bow has potential energy, which can be released in the firing of an arrow at high speed.  But, that is not the only possible outcome.  The archer can relax his bow in a controlled manner, resulting in no fired arrow at all.  So, standing in front of an archer with a drawn bow is not the same as actually being shot with an arrow.  Even so, it's not a great place to stand.

 

I agree with this 100%.  Too many people stand in front of that archer, seeing the tension on the bow getting ever tighter, saying that they aren't worried at all because they haven't seen an arrow in the air.

 

Now imagine that this bow isn't being held by a human archer at all but by a machine where one human can pull the string back as far as he wants, but has no control over when it is fired.  The firing is determined by an impossibly complex system involving trillions of variables that no one fully understands.  It isn't a great place to be standing indeed.

[Palantir]

The quantity of money injected into the system is replacing what was lost earlier during credit contraction. It does not necessarily mean that the aggregate money supply has increased.

 

Furthermore, if V increases, it should be very easy to soak up liquidity given the size of the Fed balance sheet. And if V does increase, it doesn't necessarily mean it will be a giant spring, it can be a gradual increase in velocity.

[zarley]

The quantity of money injected into the system is replacing what was lost earlier during credit contraction. It does not necessarily mean that the aggregate money supply has increased.

 

Furthermore, if V increases, it should be very easy to soak up liquidity given the size of the Fed balance sheet. And if V does increase, it doesn't necessarily mean it will be a giant spring, it can be a gradual increase in velocity.

 

Good points.  Although, it does depend on what measure of money you're thinking of.  M2 as tracked by the Fed is certainly higher now than several years ago.  Private estimates of M3 (since the Fed stopped officially tracking it a few years ago) are closer to what you describe from what I've seen (e.g., shadowstats). 

 

Now imagine that this bow isn't being held by a human archer at all but by a machine where one human can pull the string back as far as he wants, but has no control over when it is fired.

 

I think this takes it too far.  One person does not have the power to do anything of the sort.  If your one person is Ben Bernanke, he's the head of a board that has the power to influence things.  Your immeasurably complex system works on both ends of the transaction.  The Fed (not Bernanke solo) can push some levers in the system, but cannot control it in either direction.  You can't have it both ways.

 

But, none of that gets to why the misuse of the term inflation to describe monetary expansion is in any way helpful or anything other than misdirection.