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Manufacturing inflation in a wage deflationary world

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Edward here. Earlier in the month, I wrote how the currency is the real release valve for a credit based economy using a nonconvertible freely floating currency. It’s not about interest rates. If currency revulsion takes hold from negative real rates and people want to flee a country’s assets, this will be reflected in the currency. This is why the lower and lower yields in the US go against the canard about bond market vigilantes forcing rates higher.

In that post on Currency Revulsion, I wrote:

For monetarily sovereign nations, with their negative real yields aka financial repression, it is the currency where revulsion shows itself, not yields. But if deflation takes hold the currency appreciates as real yields climb. That has trapped Japan in a deflationary episode. If you want to avoid that trap, you will be forced to manufacture CPI inflation; and that means you need currency depreciation before deflation takes hold. QE has not done the trick.

Here’s the problem:

Between June 2009, when the recession officially ended, and June 2011, inflation-adjusted median household income fell 6.7 percent, to $49,909, according to a study by two former Census Bureau officials. During the recession — from December 2007 to June 2009 — household income fell 3.2 percent.

-Recession Officially Over, U.S. Incomes Kept Falling, NYTimes

How does manufacturing CPI inflation benefit an economy in which incomes are falling? When inflation rises and incomes are stagnant or falling, the economy rolls over. That’s what the British have seen, for example.

I think that’s why people are focusing on nominal GDP and why Bruce Bartlett says the Fed should just start buying stuff.

The way I read it, the focus on nominal GDP is more about increasing the real GDP part of the equation than the inflation part of the equation. What’s the transmission mechanism for how this is supposed to work? No new net financial assets are created by monetary policy.

The Federal reserve is principally concerned with asset prices, as it has been since the days of Alan Greenspan. If you recall, during the days under Sir Alan’s helm, the Federal Reserve would increase interest rates in baby steps when the economy showed signs of overheating. But the Fed would flood the market with liquidity and lower rates drastically when a recession hit. Lax on the way up and loose on the way down. This was known as the Greenspan Put because it gave investors a sense that there was a floor on stock prices.

Today, the Fed is still trying to reflate the asset-based economic model with PZ money (permanent zero – where extended period language is perpetual). But low Treasury rates affect not only stocks but mortgage rates as well – and this is important in the context of a still dysfunctional housing market. So the Fed certainly wants stocks and bond values to go up, boosting household wealth and hopefully aggregate demand with it. Notice that this also works at odds with deleveraging and with increasing the savings rate.

-The Fed wants asset price inflation not consumer price inflation

To me, this is fiscal policy by another name. But the fiscal agent adds net financial assets to the private sector by deficit spending. That’s the essence of fiscal. The monetary agent can’t add net financial assets to the system; it simply creates base money and swaps this for existing assets. That necessarily means that when the interest rate channel is ineffective as rates are zero percent, the monetary agent can only increase asset prices as the transmission mechanism for reflating nominal GDP. This is most certainly at odds with deleveraging and increasing the savings rate. It strikes me as very trickle down to boot.

If you believe that US GDP was not inflated by resource misallocation, you’ll want asset prices to be artificially boosted until the economy ‘grows into’ those prices. Larry Summers has said, "that the central objective of national economic policy until sustained recovery is firmly established must be increasing… borrowing and lending." The jobs crisis is all about demand, then.

If you believe, as I do, that the problem is excessive private sector debt and leverage due in large part to resource misallocation, you probably think growing into asset prices via increasing borrowing and lending is misguided. Debt/income and debt/GDP levels are simply too high. The government can act as a counterweight to the demand drag. But the recovery will always remain fragile until you get substantially all of the credit writedowns on unrecoverable loans. The reason financial crises are followed by slow recoveries has everything to do with this. Moreover, you want to focus on income and not GDP because the household sector is indebted and it pays for debt out of income; higher GDP doesn’t make any difference for debt service unless it is felt in household income.

Try to manufacture inflation all you want, manufacture nominal GDP all you want; until incomes rise enough to support the debt (numerator) or you get enough credit writedowns so that incomes support the debt (denominator), it’s not going to work.

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This entry was posted in Federal Reserve, Guest Post, Moral hazard, The destruction of the middle class on by .

About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward

91 comments

    1. Jim Elliot

      Hadn’t really thought of Malthus for a while. But I have considered that when the Egyptians built the pyramids, there was clearly an excess of labor and 80% worked in agriculture. We might enjoy the pyramids, but I see a misallocation of labor to a number of useless projects that had no economic value. Now I think that the number of laborers working in agriculture is probably 8% and ther rest of us get to build Iphones and video games to keep busy. Probably an exponential increase in the anount of excess labor. Most of us really are expendable in terms of economic utility. I think we have to be changing the nature of economic thought.

  1. Timothy Gawne

    Interesting stuff, but an orthodox Keynesian analysis suggests another view.

    Keynes was first and foremost a disciple of Malthus, and if you read what he actually wrote, it’s clear he felt that demographics was at least as powerful – if not more powerful – than finance, and you should never ignore physical reality.

    We are adding about 100 million new mouths to feed each year. We are long past the time were we could just pump more oil and dump more fertilizer on the crops. Our current technologies are increasingly subject to the law of diminishing returns. Supply and demand suggest that, over the long run, wages will fall and prices for food, water, etc. will rise (at least relative to wages). Finance can tinker around the edges but it can’t make physically impossible things happen, and by focusing only on money we are missing a big part of the picture.

    Thank you for your consideration,

    1. R Foreman

      Vast amounts of resources sit idle since they’ve been looted from the public by a tiny 1% of the population.

      We could make feeding the entire population a physical possibility by rounding up that 1% of global looters, herding them into a barn, then setting the barn on fire. We could then conduct a land rush of the newly unclaimed resources, similar to the 1889 Oklahoma land rush, with free property for anyone willing to squat and farm.

      Thank you for listening.

    2. run75441

      Timothy:

      Since when? We occupy 5% of the land of this nation which leaves much space for crops and other foods. We can still grow more. Joel Garreau “300 million and Counting” has a nice article on the topic.

      1. Fiver

        Africa is being carved up willy nilly and sold to uber-wealthy Americans, Chinese, Indians, oil kingdoms, all orchestrated by the World Bank, and all in recognition of an intense global food crisis right around the corner (that is, if you are not part of the 1 billion already experiencing it). US food growing practices have badly damaged virtually all of the major river drainage basins, the Great Lakes, and the Gulf of Mexico. It takes more toxic crap to grow the same volumes every year, which is killing the soils. The “Green Revolution” has largely come undone – it never was more productive AND blithely eliminated most of rural population’s store of knowledge of all sorts needed to return to a less lethal alternative. Throw in just 1 serious drought/crop failure in 1 major global food-producing region and you’d have a global food crisis now, let alone 20 years from now. There is nothing remotely adequate in storage to replace 1 major failure. They happened numerous times over the past several hundred years. We’ve been unbelievably lucky for the most part, and particularly recently having so foolishly adopted mono-culture practices.

    3. Fiver

      Right you are.

      We are adding billions by mid-century; we are living far longer; we have opted for capitalism, which is premised on exponential growth; and we have only 1, already badly damaged planet.

      It cannot, and will not, work. We have about 2 decades before it’s too late to make changes big enough and fast enough to avert eating a heaping plate of consequences – and they are grim indeed.

  2. diddywa

    Gosh, off thread and topic, but need to mention, NC site-loading performance has gone from low-mediocre to bad — one of the worst.

    Seems that kind of performance is critical to popularity. See also google. From my experience, the tech guy has probably tried everything to improve it, short of something drastic, like changing platforms, or limiting certain ad types. It may be time for major steps.

  3. nmtdoc

    Yes, many days this site loads at the pace of a snail. Not to criticize mind you. Just thought you might not be aware.

  4. alex

    Edward Harrison: “How does manufacturing CPI inflation benefit an economy in which incomes are falling? When inflation rises and incomes are stagnant or falling, the economy rolls over.”

    Thank you for pointing this out. It should be obvious but is often overlooked, including by economic commentators that I generally agree with (e.g. Krugman).

    The idea that inflation will help reduce the household debt burden is based on the (generally unstated) assumption that labor has enough bargaining power to demand wage increases commensurate with inflation. Does that sound like today’s economy?

    The 1970′s are over but certain people haven’t noticed. Fighting the last war and all that.

  5. Tao Jonesing

    How does manufacturing CPI inflation benefit an economy in which incomes are falling?

    Why do you assume that benefitting the economy as a whole is the goal?

    Your quote from Larry Summers should tell you who are the intended beneficiaries of the policies that are manufacturing CPI inflation in an economy in which incomes are falling, and they all reside in a very specific segment of the economy.

    1. Moneta

      It would benefit the young and the workers over the retirees… with pensions and entitlements losing value.

  6. steelhead23

    Aw yes, real wages must rise. But the question is – how? I can think of some ways (e.g. protectionism) but even that conversation would be premature. We are having a dickens of a time writing down the bad debt. Until we’re ready to bite that bullet, all talk of economic recovery is make-believe.

    1. noe

      talk of protectionism is premature?

      I remember a bit of self evident truth by Sir James Goldsmith back in the early 90′s – he said FREE TRADE will destroy America.

      Our wages will fall until they are commensurate with those of the third world – and since birth rates in the 3rd world are still out of control – we are in free fall.

      Then Jeremy Rifkin wrote The End of Work in 1996. Again, he warned of the evils of outsourcing.. and warned that 3/5ths of humanity would be redundant in the coming century.

      I just went back and reread his ‘solution’ in the last chapters. There is none.

      Public employment, paid for by government. Make Work.

      So long as our wages are dictated by the lowest common denominator – home prices, consumer prices and living standards will plummet or their won’t be any buyers.

      This is just so self evident… and was when I first read it.

      Perot tried to tell us… corporations will move to where ever they can produce on a dime, destroy the environment, and sell with no taxes.

      So long as we import their products without penalty, we are doomed.

      Sure, Levi’s will come home. Anybody see what they’ve done to the rivers and creeks surrounding their plants in Mexico and the Philippines? All BLUE… the locals are furious, but the governors are bought and paid for.

      So what is the future for the planet with this paradigm??

      The corporate model is evil by definition.. .and should not be a part of the solution.,

      1. LucyLulu

        And then there is oil production in Nigeria. Allegedly the average lifespan there is now only 44 yrs. Broken pipelines are left to lay deserted and spewing oil, there are hundreds of them. Children swim in water holes covered with a layer of oil. The leaves on trees glisten with an oily film. The government officials can be paid off cheaply. A large part of our foreign oil comes from Nigeria.

        Yet, the oil companies say our regulations are too burdensome (despite no changes since the BP spill)???

    2. Dan Kervick

      Well, since the median real wage declined even after the recession supposedly ended – i.e. even as per capita income was going up – the problem would appear to be that too much of our national income is flowing toward the top. So we just need to redirect that income toward everyone else.

  7. Doug Terpstra

    Brilliant post, Edward, a clear revelation of self-evident truths. BTW there’s an excellent website, second only to NC, that explains much of this stuff in terms the rest of us can understand:) http://www.creditwritedowns.com/

    FDR rebutted Larry Summers long ago:

    Primarily this is because rulers of the exchange of mankind’s goods have failed through their own stubbornness and their own incompetence, have admitted their failure, and have abdicated. Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men. True they have tried, but their efforts have been cast in the pattern of an outworn tradition. Faced by failure of credit they have proposed only the lending of more money. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence….The money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths. The measure of the restoration lies in the extent to which we apply social values more noble than mere monetary profit.

    Many of us had hoped Obama might seize the mantle of FDR and stand even taller on his shoulders; alas, instead he hired one of the chief money changers, Summers, and all the old warmongers too. Perhaps this too was necessary for decrepit system to finally be put out of our misery.

  8. Philip Pilkington

    “Try to manufacture inflation all you want, manufacture nominal GDP all you want; until incomes rise enough to support the debt (numerator) or you get enough credit writedowns so that incomes support the debt (denominator), it’s not going to work.”

    Maybe I’m missing something here, but if they can get the inflation rate up (big if, but that’s the hypothetical here) it will wipe out debt. Inflation wipes out debt.

    So, provided real incomes remain stagnant (i.e. are not eroded due to inflation by being ‘pegged’ to rising CPI), ceteris paribus, debt will decrease relative to nominal incomes.

    This is why financial types HATE inflation. It is a transfer from the creditor (and saver) to the debtor.

    1. Philip Pilkington

      Should read:

      (i.e. are not eroded due to INCOMES by being ‘pegged’ to rising CPI)

      Sorry.

    2. eric anderson

      So it appears you hate the savers as well as the “financial types.” Grandmothers and grandfathers. That’s very nice. Screw gandma to save the mass of idiots who took on more debt than they could handle.

      1. Binky the Bear

        Yes, those foolish idiots whose jobs disappeared in a morass of corrupt outsourcing and business fraud; those morons who got sick on purpose just to screw up your sense of moral hazard; those fools who should have moved to China when America’s capitalist elite decided that despite the Red Star, hammer and sickle branding, China was a great opportunity to spread totalitarian capitalism.
        You are a Winner!

        1. eric anderson

          Well, I’m sorry, but shit happens. One should plan for such things by not borrowing up to the eyeballs. Sheesh! This is simple common sense. I do not see any justification for screwing the prudent to protect the imprudent from their stupidity. Frankly, I think that is immoral.

      2. Linus Huber

        I definitely am on your page here Eric. We first have to get back to a state where the rule of law represents some form of justice as felt by the population. Presently all those crooks are still having the time of their life instead of rotting in jail.

    3. mmckinl

      Inflation would only hurt at this time. Both the labor market and the goods markets are lacking demand.

      Inflation would only make the cost of living rise without wage increases.

      Inflation would only be a drag on goods as there is no mechanism to increase purchasing power leading to demand destruction.

      1. Philip Pilkington

        @ eric anderson

        No value judgement. Just saying what inflation does with regards debt.

        @ mmckini

        Just pointing out what happens if inflation occurs with regards debt. That’s what Ed was talking about.

        1. steelhead23

          You said that inflation kills debt. That is not true. Bankruptcy kills debt. Inflation kills savings as there would be no incentive to save if nominal interest rates were lower than CPI inflation. As a saver (I really would like to retire one day), I strongly prefer reducing the debt overhead via bankruptcy rather than inflation, but Ben doesn’t listen to me.

          Are you Occupy WallSteet folks listening? Occupy the New York Fed – they’re doing Wall Street’s bidding, not ours.

          1. Philip Pilkington

            I beg to differ. Inflation DOES kill debt. You just don’t want inflation because of personal financial concerns. Fine. But you can’t make up your own facts.

          2. Foppe

            Well, inflation without usury. When you have 250-600% yoy interest rates, inflation isn’t going to do much.

          3. Dan Kervick

            Phillip,

            Inflation only heaps with deleveraging if the debtor’s nominal income rises along with prices, so that real income remains constant. That way, since the debt bill is pegged to nominal dollar amounts, the real value of the debt falls and the debtor pays it off faster.

            But in the current economy, with massive unemployment and no bargaining power, people aren’t getting raises. Employers are taking advantage of the tough times to reduce their employees’ real wages through inflation. As a result, the deleveraging effect doesn’t occur for all people. And for those most vulnerable, it doesn’t occur at all. So all they receive as a result of inflation is a real increase in household costs.

          4. Linus Huber

            I agree that inflation kills debt but only upto a point. Once confidence in a currency is lost you have not simply inflation but hyperinflation. At that point in time, not only debt is killed but the economy as a whole as well.

    4. Fed Up

      “Maybe I’m missing something here, but if they can get the inflation rate up (big if, but that’s the hypothetical here) it will wipe out debt. Inflation wipes out debt.

      So, provided real incomes remain stagnant (i.e. are not eroded due to inflation by being ‘pegged’ to rising CPI), ceteris paribus, debt will decrease relative to nominal incomes.”

      Yes, you are missing something. It is called wealth/income inequality, medium of exchange, and budgeting.

      Try that with your personal budget. Run up a bunch of debt so that interest payments and living expenses comprise your whole budget. Now start raising prices for food, gasoline, electricity, etc. with no wage increase so that those firms become more profitable. See how that works out.

      “Inflation wipes out debt.”

      That is a macroeconomic overstatement, which does not have to be true. Stop listening to macroeconomists and their overstatements and generalizations.

      1. Philip Pilkington

        “Now start raising prices for food, gasoline, electricity, etc. with no wage increase…”

        But I said that real incomes remain stagnant. So, we’re assuming that nominal incomes are indexed to a large extent to rising prices.

        I think there’s some confusion here over nominal and real income. I also think there’s some confusion between general inflation and rising commodity prices due to speculation…

        1. Fed Up

          “Now start raising prices for food, gasoline, electricity, etc. with no wage increase…”

          But I said that real incomes remain stagnant. So, we’re assuming that nominal incomes are indexed to a large extent to rising prices.

          I think there’s some confusion here over nominal and real income. I also think there’s some confusion between general inflation and rising commodity prices due to speculation…”

          No, I focused on the “Inflation wipes out debt” part. I may have misread the second paragraph where you said, “real incomes remain stagnant” (remain negative???). If the labor market is mostly oversupplied, there is no reason to believe that wages will keep up with prices.

          I’ll add health insurance, water rates, sewer rates, etc. to food, gasoline, and electricity.

          1. eric anderson

            You could add taxes, too, as states and localities get caught in the bind of too many promises made, and no way to print money to fulfill them. They cut wages/bennies for employees (so much for their real incomes), and raise taxes.

    5. brazza

      That is definitely the objective – to wipe out debt through inflation. Problem is, as this excellent post points out .. it ain’t working! We are irrevocably engaged in a deflationary spiral and there are no strings to pull to change course. The constant-growth myth that undergirds modern society has irrevocably lead to imbalances that will be rectified. We should be solely concerned with steering the deflationary ship … its no longer possible to change course.

      1. Philip Pilkington

        “That is definitely the objective – to wipe out debt through inflation. Problem is, as this excellent post points out .. it ain’t working!”

        Well, that’s beyond doubt. I think we all agree that current policies stink to high heaven — QE being a major offender.

        But I just don’t think we should completely dismiss the idea of, given the right policy mix, using inflation to wipe out debt. It might well be effective in the future under different economic circumstances. Indeed, it might be necessary.

        1. brazza

          I concur with a non-dogmatic approach making use of all available tools to create what you describe as a policy-mix, but within a general acceptance of the need for a dramatic change of course – not in an attempt to re-gain a status-quo which is inexorably over.

        2. Linus Huber

          Another aspect should not be underestimated. One may choose the inflationary path but in a general credit contraction it becomes very obvious who is the beneficiary of such policy. It shows up in the form of total injustice to the large section of the populace and it might result in revolt by those who basically are left to carry the burden.

          1. Nathanael

            Let’s put this more simply. What we need is wage inflation, not price inflation.

            How best to generate wage inflation?

    6. Tim

      Phillip,
      Think about it this way. You make $1000 per month, and make $500 in morgage and other debt payments. Assume CPI inflation is somehow raised to ten percent via QE or some other mechanism of the Fed trying to reinflate (per shadow stats it’s currently ~5%), but unemployment is still 10% so unless you want to be replaced by one of the 10% you continue to work for $1000 year after year.

      Is that $500 a month in debt payment getting any easier for YOU in that situation? No, of course not which is exactly the point Edward is making.
      That is the fallacy of the 1970s thinking that inflation is due to rising wages, it isn’t this time, it’s due to the Feds monetary policies, which is not improving our ability to deal with our excessive debt.

      Fiscal has not targeted incomes, so the most obvious option B is Deflation and debt writedowns. So far our bought government has chosen neither and prefers economic contraction and inflation at the same time, hence the motivation for OWS…

  9. Hugh

    So if the rich and corporations send jobs and industries over to China, as they have been doing for years, is this currency revulsion? On the other hand, they still own 70% of the country and 90% of the stock and bond markets, so how would goosing stocks and bonds help ordinary households. All Bartlett’s plan sounds like is a reprise of QE1, buy drek from the banks and lots of it. Finally, as Tao Jonesing indicates, CPI inflation does not help the 99%. It doesn’t keep their incomes from falling. It doesn’t raise the values of their assets. It just means their income picture is even worse. They have fewer dollars and can buy less with them.

    1. eric anderson

      Yes, this is quite obvious, except to the intellectuals who would tell us that money printing will cure a rainy day.

      1. Nathanael

        The key question is WHO the printed money goes to.

        There are an awful lot of us intellectuals who think that printing money *and handing it to the average people* — rather than to major banks — like F. Beard’s plan to print money and mail equal amounts to every man, women, and child in the US — would really just solve the problems.

        Money-printing does nothing if you hand the printed money to the same old elite criminals. If, on the other hand, you print large amounts of money and hand it to *debtors* and the *poor* and the *working classes* (the bottom 90% now), you get major improvements. That process includes inflation, but the redistributive aspects of it compensate entirely for the inflation.

    2. Cynthia

      It didn’t help that our corporate elites sold their souls to Chinese authorities in order to amass enormous wealth by employing the people of China to work for sweatshop wages. For a while there the American people benefited from this by being able to maintain a cushy consumer lifestyle without having to break the bank.

      But now that American wages have deflated to the point where even the cheap stuff at Walmart and Disney World has become unaffordable to most Americans, our corporate elites will soon start feeling the pinch of asset deflation. Apparently greed got the better of them, otherwise they should’ve known better than to think that deflating wages won’t eventually lead to deflating asset prices. They should’ve known better than to think that making others poor won’t eventually make themselves poor.

      1. reslez

        They should’ve known better than to think that making others poor won’t eventually make themselves poor.

        They don’t care as long as they have more than everyone else. “Unenlightened” self-interest.

    3. Philip Pilkington

      “CPI inflation does not help the 99%. It doesn’t keep their incomes from falling.”

      If the incomes are indexed they don’t fall.

      “It doesn’t raise the values of their assets.”

      Depends.

      “It just means their income picture is even worse.”

      Depends on to what extent their incomes are indexed as well as other factors.

      People shouldn’t see inflation as a bogeyman. It has good and bad elements to it. It can negatively affect crisis conditions (as it is clearly doing in the UK), but the right type of inflation could lead to automatic debt wipeout.

      When people hear the word ‘inflation’ they think ‘badness’. But its a little more nuanced than that…

      1. diddywa

        I used to carry a William Greider article ‘The Shadow Debate about the American Economy’ with me. This was decades ago. He argued inflation could be _good_ for the working class — the only time real wages can actually rise. Not to mention debt deflation.

        Maybe there has to be good employment rates in effect, like back then. I don’t know. But I’ve started to find some MMT arguments pretty interesting (and that article arguing against standard economic assumptions like the rational constrained utility maximizer was powerful for me — it’s always amazing when you see how paradigms true or false shape your whole world view, ones you barely even thought you had).

        1. Philip Pilkington

          I believe that is true. I think China are facing this dilemma now. Every time they try to raise living standards they get inflation. But there’s every chance that during eras where living standards are pulled up significantly, inflation is the norm. This is what JK Galbraith argued back in the early 60s, and if we look at Latin America I think we see further evidence.

          Strict inflation targeting may well be very wrong-headed in the developing world. (And here, if we want to wipe out debt).

          Thank you for saying that about the article on utility. That’s very kind. Benthamite ideas of utility-maximisation have soaked to the roots of our collective consciousness. When looked at closely though, they don’t make any psychological sense.

          I’m actually having an email correspondence with that mathematician that Yves posted on here (Andrew Dittmer) a while back about this. I might ask him if you can formalise this argument mathematically because I suspect you can actually show that what the neoclassicals call ‘utility’ is not a real number — ordinal or otherwise. And it’s just — like Newton’s Fluxions — a ‘ghost of a departed quantity’.

          1. craazyman

            Utility is what you thought you’d be getting before you got it. :)

            I will readily believe anything Mr. Dittmer says, based on his last tour de force performance.

          2. Joe Rebholz

            ” … neoclassicals call ‘utility’ is not a real number… ”

            The classicals might have thought it was a real number, but what modern understanding of human behavior shows is that, if anything, it would have to be some huge vector — a point in some multidimensional metric space of human thoughts and feelings, if “utility” can be made sense of at all.

          3. Philip Pilkington

            @Joe

            The neoclassicals consider it to be an ordinal number. I.e. one given in relation to something else. So, I may prefer apples:bananas on a ratio of 2:1. Etc.

            Needless to say, this is nonsensical for a number of reasons. It’s not an ordinal at all. It simply doesn’t exist.

          4. Skippy

            “Newton’s Fluxions” ??? your too kind Phillip.

            I would have utilized his *Lions Heart*, as in his Alchemist studies, more accurate…methinks.

            Skippy…as a man that sent many to the tree, I wounder what his top 25 candidates would be today?

          5. Nathanael

            Indeed, inflation is unavoidable and desirable when the standard of living is going up.

            You want to avoid hyperinflation (and you can). And you want to avoid the nasty situation where prices go up, but wages and social programs go down, which is what we have now — that’s not inflation, that’s “austerity”.

            (I specify wages and social programs, because it works out OK if wages go down but everyone gets a lot more from the government, for instance free health care — standard of living still rises.)

      2. Roland

        People working in the real economy don’t enjoy indexed incomes.

        Even retirees receiving “indexed” pensions are often–and easily–shortchanged by rigged methods of calculating official inflation rates.

        Unless you have pricing power for your labour, inflation will leave you behind. There is a significant difference between today and the 1970′s.

        It is quite possible to have inflation in many commodities, along with stagnant or declining incomes. History abounds with examples, although many of them are drawn from wars, sieges, and so forth.

        What makes it possible is the human being’s astounding ability to endure physical misery.

        Inflationistas are going to be stunned by just how much misery their ideas will bring about.

        Then, hopefully, they will be physically liquidated during the protracted period of violent unrest that will probably follow.

        History abounds with examples…

        1. Nathanael

          The crucial aspect of inflation is wage inflation.

          If you don’t have wage inflation, you don’t have real inflation. Price inflation without wage inflation is something else — it’s nasty austerity.

          What we need is wage inflation. If that translates to price inflation plus wage inflation, that’s *OK*, which is what the sane pro-inflation people are trying to say.

  10. Cynthia

    Fred Bergsten of the Peterson Institute seems to think that inflation, via a weaker dollar, will help spur economic growth:

    http://www.nytimes.com/2011/09/29/opinion/an-overlooked-way-to-create-jobs.html?hp

    Notice that when Main Street started to suffer from wage deflation, inflation hawks like Fred Bergsten opposed bailing out Main Street on the grounds that it would cause too much inflation to creep in and cripple the economy. But now that Wall Street is heading back down the deflationary spiral again, causing widespread asset deflation, they have switched their tune and are now talking about how inflation can act to stimulate growth in the economy. So to them, inflation is something to avoid when Main Street needs a bailout, but it’s something to embrace when Wall Street needs a bailout. What a bunch of self-serving hypocrites these folks are!

    Come to think of it, the only two areas on Main Street that aren’t suffering from wage deflation are higher eduction and health care. But once Wall Street figures out a way to outsource them to low-wage countries, believe me, they too will get sucked into a deflationary spiral, goin’ down, down down, along with the rest of us workers on Main Street:

    http://www.youtube.com/watch?v=2UIptI2rcjg

    1. alex

      “inflation, via a weaker dollar”

      A “weaker” (more competitive) dollar would have some unfortunate tendency to increase inflation, but would also have the very desirable effect of increasing demand for US produced goods and services, through both increased exports and greater import substitution. It’s a very different animal from conventional domestic inflation.

      It’s a classic, and classically successful, approach for a country with a trade deficit and a depressed economy to increase demand for domestic production. Just because it was touted by somebody from the Peterson Institute doesn’t make it a bad idea. Stopped clock and all. If you’re interested in provenance, Dean Baker is also a big advocate of a more competitive dollar.

      1. reslez

        They’re seeing trees while forest-blind. Our trade partners would yell bloody murder if we tried to hatchet the dollar. They’re all trying to weaken their currencies too. Who exactly is going to buy these imports?

        Export profits are skimmed off the top, there’s no no wage leverage for workers. We need to stimulate domestic demand not hope that foreigners will solve our problems. That holds true for every country not just the U.S.

      2. toxymoron

        I remember the time when everyone liked the weak dollar: more demand for American products, more jobs etc..
        They learned only three (miserable) years later that with a weak dollar, IMPORTs cost much more, and the US does a lot of importing. So while it takes time to gain market share and employment and all that stuff from a weaker dollar, more expensive iPADs, more expensive fuel, … and more suffering is immediate.
        A weak dollar is as bad as a strong dollar (or yen, or euro, or whatever). A stable dollar is a good thing. Everything else is pain for the 99% (and a gain for the 1%).

  11. KnotRP

    > So, in other words, Gentle Ben is pushing on the wrong string?

    Worse…he’s forcefully pulling on a rope which has a disposable income noose around the average citizen’s neck. He’s actually choking off disposable income (and thus the ability to consume), thinking he’s helping….

    Nice post, Edward. Exactly right.

    1. jake chase

      There is only one thing Bernanke is pushing on, when he isn’t pulling on it. All talk of cpi inflation is idiotic. Every seller will raise its price whenever it can, and what is keeping inflation in check is competition. The real economy can be resurrected only by government make work and we will get it sooner or later. Or maybe we’ll get a major war and a draft. The only goal of monetary policy was to save the bank creditors and shareholders and it has worked perfectly. To believe anything else you have to be an idiot or perhaps an economist.

      1. Joe Rebholz

        “The real economy can be resurrected only by government make work …”

        Why does it have to be make work? Aren’t there enough human needs that it could be real work?

        1. Tim

          No there aren’t, unless you consider people riding bycycles in place tied to a generator generating extra electricity as worthwhile. That is the big picture problem somebody else erlier in this comment string referenced. Productivity increases compounding will only increase the problem indefinitely into the future.

          1. Nathanael

            Actually, there are enough real needs. For now there are, anyway. (The problem of everything-being-done-by-robots is a real problem, but a problem for a future decade).

            Right now, we NEED to completely retrofit our entire energy production system to eliminate CO2 emissions. We WANT to provide high-quality transportation for the population. We WANT to eliminate choking, toxic pollution. This would employ plenty of people. Unfortunately there are entrenched interests who don’t want to do any of that, because their oil profits would drop. And it really can only be done by government incentives, because too many of the benefits are non-excludable.

            After we have our all-solar, all-robotic economy, we can deal with the problem that there’s not enough real work which needs to be done. But right now, there’s plenty.

            As an important point, John Maynard Keynes discussed exactly this situation: he said that there were plenty of useful things to do, but that for some reason the politicians of the day were actually *more* willing to create make-work jobs digging holes in the ground than to create *useful* jobs. (Digging holes in the ground was a sly reference to gold mining, actually….)

    2. ajax

      For a consumer with debt, the break-even point
      between ever-increasing debt and a chance at
      decreasing personal debt to zero is the ability and
      willingness to meet interest due on the current debt.

      Is there a measure of income of workers that deducts
      from gross income : taxes, social security *and*
      accrued interest? For example, in a three-month
      period, this measure of income would deduct from
      gross income: taxes paid, social security fund
      dues *and* interest accrued in the three-month
      period on consumer debt, mortgage-related debt,
      student-loan debt?

      1. Nathanael

        I think I’ve seen such an analysis. Something between 10 and 20 percent of all American workers have no income using that measure.

        In actual fact, they are simply not paying the interest due, and if their paychecks get attached, they declare bankruptcy or start working “under the table”. They have to pay for food and shelter before they’re going to pay lenders.

  12. KnotRP

    > Maybe I’m missing something here, but if they can get the
    > inflation rate up (big if, but that’s the hypothetical here) it will
    > wipe out debt. Inflation wipes out debt.

    If wages stay stagnant or decline (as they have been, and will continue, as we trend towards a globalized lifestyle) the prices of necessities (like commute fuel) will consume an increasing part of the stagnant/declining income, thus crowding out disposable income.

    Therefore, debts will default well before inflation can wipe them out. Inflation is not a cure when there is no wage spiral.

    1. JPM

      We have already hyper inflated homes and cars while stagnating our wages and benifits since 1990. We have maintained our GDP to some extent by raising the prices 100+% on the goods we need on a daily basis. Consummers do not have any degressionary income these days as they struggle to get by. We have a four class society. The 1% who controll all the wealth and the 3 parts of the 99%, Working, non working, and the absolute poor. I think we are on coarse for a Chinese revolution where we redistibute the wealth.

      Pumpng up home values is not the answer as for most folks they cannot afford them at even half the price let alone the real estate taxes and up keep.

      JPM

      1. JPM

        As a follow up on hyper inflating our homes this is now done out into the future with 30 and 40 year contracts. The only way one can afford a house even with cheap 4% interest rates is to finance the home out 30 or more years. so home owners are committed to a life time of payments. In the past it was possable to do a 15 year contract and for many by the time they were 40 years old their home was paid for and then they had lots of desgresinary income.

        JPM

    2. Nathanael

      But they’ve made it illegal for most people to discharge debts in bankruptcy. So what next? Revolution, I guess.

  13. Fed Up

    “For monetarily sovereign nations, with their negative real yields aka financial repression, it is the currency where revulsion shows itself, not yields. But if deflation takes hold the currency appreciates as real yields climb. That has trapped Japan in a deflationary episode. If you want to avoid that trap, you will be forced to manufacture CPI inflation; and that means you need currency depreciation before deflation takes hold. QE has not done the trick.”

    Sounds to me like someone does not understand medium of exchange.

    The other thing to consider is whether currency depreciation is really about increasing net exports.

  14. Edward Harrison Post author

    The overall point I am making here is that we have household sector balance sheet problems. Unless you fix the debt/income number instead of the debt/GDP number, the balance sheet problem remains. Eroding the real burden of debt is dependent not on raising nominal GDP, but on raising nominal income to keep pace with consumer price inflation. Even holding real incomes constant means a hard slog to deleverage.

    The problem is that the policy response is geared toward monetary policy that works through the interest and asset value channel and therefore doesn’t really address the main issue, household incomes and debt. And this will continue to be the case on reflating the economy, unless fiscal is used to target incomes, by adding net financial assets where incomes have been worst impacted. A lot of economists are talking about ‘market-clearing’ wage prices, that is LOWERING incomes, to reduce unemployment. That will make the debt problem larger. Otherwise, you have to rely on deflating the economy i.e. credit writedowns, to get debt and income in sync.

    1. alex

      “A lot of economists are talking about ‘market-clearing’ wage prices”

      Yes, although economists who haven’t heard of Keynes or dismiss his most important insights may be referred to as “ignorant idiots”. That’s the charitable label, the other is “sycophants of the plutocracy”.

      P.S. Thanks for a post that makes some excellent points.

    2. gizzard

      Thank you for making the point Edward that the policy goal of many is lower wages.

      Seems to me the correct response here is similar to the snarky response given to the idea of the “Buffet Rule”. If you think incomes are too high, go to your boss and offer a 20% wage cut, Im sure he’ll accept it. Talk your buddies into it too. Telll them its about being a good American.

    3. Fed Up

      “The overall point I am making here is that we have household sector balance sheet problems.”

      I think that needs broken down. IMO, there is a lower and middle class debt problem (balance sheet problem). How many rich households have a debt problem (balance sheet problem)?

      “And this will continue to be the case on reflating the economy, unless fiscal is used to target incomes, by adding net financial assets where incomes have been worst impacted.”

      If by fiscal you mean gov’t debt, then I disagree. The solution to too much lower and middle class debt owed to the rich is not more gov’t debt owed to the rich. IMO, there is a medium of exchange problem that has thrown the retirement market off because of certain poor assumptions by economists and rich people who like those poor assumptions.

      1. Nathanael

        The household balance sheet problem appears to apply to most of the bottom 90% at least. In fact, to a large portion of the top 10%. Only the top 1% is largely clear of balance sheet problems.

        So yes, many of the rich and most of the superrich do not have balance sheet problems.

  15. Hugh

    I am describing what is currently happening in this country, Philip. I’m not real clear what your comments are referring to.

    “If the incomes are indexed they don’t fall.”

    Outside of Social Security, incomes aren’t indexed to inflation. Even with SS, the Obama Administration has been pushing to move to a chained CPI which would cut the level of the indexing. The recent study by the former Census people showed that real median income had declined by 9.8% since December 2007. So incomes are falling.

    Housing prices continue to fall so ordinary Americans are seeing the value of their major asset drop.

    The commodities price inflation, especially its effects on gasoline and groceries, cut into the buying power of ordinary Americans. This was only partially offset by lowering the payroll tax.

  16. KnotRP

    I’ve been wondering for a while why Philip Pilkington seems so hopelessly out of touch with reality….until I read this:

    > “If the incomes are indexed they don’t fall.”

    Now I understand that Philip lives in an alternate/sheltered universe where wages are set by one’s own mother…perhaps he even lives in her house, and has fixed rent (or maybe he just has to take out the garbage). Most of us don’t live in a world where incomes are indexed….

    1. mario

      Theoretically, income can be indexed simultanieously with lowering taxes, both corporate and individual.

  17. mario

    “you will be forced to manufacture CPI inflation; and that means you need currency depreciation before deflation takes hold”

    Agree. Because:
    1. Currency depreciation could bring some jobs home and increase local production vs outsourcing.
    2. Aseets, including Real estate would appreciate… read new ATM
    3. Banking – balance sheets would be significantly improved.

    Cons: for those who keep the wrong kind of assets wealth would beminish. Call it redistribution.

    It feels like I missed somethin though…

    1. KnotRP

      > It feels like I missed somethin though…

      You did. If the major outsourcing/offshoring locale is also pegging to your currency, the jobs don’t come home and
      the whole thing falls apart….

  18. mario

    “you get enough credit writedowns so that incomes support the debt ”

    This can be done with the same model finance industry was bailed out – cheap credit.

  19. Jim Haygood

    ‘If you believe that US GDP was not inflated by resource misallocation, you’ll want asset prices to be artificially boosted until the economy ‘grows into’ those prices.’

    Far from being raised by resource misallocation, US GDP growth has been crippled by decades of malinvestment in unproductive cultural wars and shooting wars.

    We’ve already tried the ‘boosting asset prices’ bit. How about ‘growing into’ those bubblelicious housing prices of 2006? How’s that working out for us?

    Now Benny Bubbles is having a go with another asset, pegging T-bond prices at levels that ol’ Crazy Eddie would properly call ‘INS-A-A-A-A-A-A-A-NE!’

    Every harebrained attempt by the central planners to peg asset prices makes the malinvestment worse. A few decades of that nonsense, and pretty soon you’re frickin’ poor.

    Benny Bubbles is the problem, not the solution. Abolish the Fed and kill it dead.

    1. mario

      “We’ve already tried the ‘boosting asset prices’ bit. How about ‘growing into’ those bubblelicious housing prices of 2006? How’s that working out for us?”

      Can’t boost the prices without boosting the income, that’s the whole point.

  20. Moneta

    I don’t know. In my mind, QE was a warmup.

    Without it GDP might be 10 trillion or less today. That is a from of inflation.

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