Thank you, and I also agree that statement you quoted is gibberish.

In addition, THANK YOU for your point on inflation expectations — this has been a niggle of mine for a while. Inflation expectations are a fantasy inasmuch as they are anything besides people’s experience of recent past inflation.

When Bernanke persistently invokes “inflation expectations” what he’s really doing is hedging: if inflation remains anchored, then the central bank pats itself on the back for a job well done. But if inflation gets out of control, the central bank blames the people for having “inflation expectations”.

Total and utter disingenuous nonsense.

In fact, one can disprove “inflation expectations” with a simple thought experiment. Start with the case where both inflation and inflation expectations are benign and low. Assume that inflation expectations can actually trigger inflation. For this to happen, then, at least someone somewhere must have and act upon an expectation of higher inflation.

If this person is a consumer, they will hoard goods, only to find out that the inflation they expected does not materialize, which leaves them with surplus goods at a lower marginal utility, which they then must liquidate at a loss.

If this person is a producer/retailer, they will raise prices. Since their peers do not yet share their inflation expectations, they will not follow suit, causing the price-raiser to lose a disproportionate amount of business. This quickly puts an end to any “expectations-based” inflation speculation.

Conclusion: inflation leads inflation expectations, not the other way around.

Corollary: inflation is always the fault of central bankers, not the people.

Corollary 2: Bernanke is either superstitious or dishonest.

But when wages are essentially frozen (at least for those who produce real goods), and prices keep going up, things seem broken to my economically uneducated self.

mjc

http://www.ny.frb.org/markets/pomo/display/index.cfm?showmore=1

Which means inflation expectations are nothing other than the experience of inflation.

For example, the current credibility of the Fed in fighting inflation is nothing other than the experience of low inflation. This is the so-called anchor.

The commenter is correct about cost-push inflation being totally outside the current discussion. Why? It can hardly be said that demand is driving up prices.

This comment: “… it is not yet clear whether the type of financial shock we are currently facing will ultimately have a negative impact on potential, rather than cyclical, output. In other words, it is uncertain whether this is a shock that may affect the degree of efficiency of our financial markets. If that were the case, that same shock may produce an upward, rather downward, pressure on the output gap.”

Is nonsense.

Any nation that exports most of its goods, materials, and energy, is likely to see inflation as the value of its currency falls on the exchange, all other things equal — even if the reason for that fall is a “deflationary” collapse in its financial markets. How counter-intuitive!

Any analysis of the episode of the 70s that ignores cost-push inflation is ascribing far too much influence to the supply/demand endogenous model. This is at best 1/3 of the picture: the other two elements are exchange effects (as noted above) and money/credit quantity.

On that latter point, we have been increasing the money quantity steadily for the past few decades, with benign effect on inflation until recently. That is likely due to “sterilization” of money and credit into the financial economy. When the point of collapse is encountered, we are liable to see much of this already-created money and credit suddenly “spill back out” into the real economy. This would be a “crack up boom” or “flight to real goods” effect and we are arguably already seeing it.

If one were to look around for classical evidence of this sort of effect, one wouldn’t see it: most normal individuals don’t have any wealth to protect. But the real place to look is the world of massive unregulated investment funds (hedge, proprietary trading, sovereign wealth). That is why we are seeing such powerful moves and high volatility.

I think the author is right in worrying about inflation, but like most mainstream economists, his model is woefully limited and outdated. These silly industrial capacity models are quaint, at best.

If the Europeans think inflation is bad now, imagine what happens when investors realize that European central banking is just as bad as US, and the rise of that currency reverses.