Like Kneading Bread

From the 27th:

Sure, you can suppress the quantity of money and thereby keep demand, and inflation, and growth, at a low level. But that does not mean it was demand-pull inflation.

If there are cost-push forces at work, suppressing demand will not solve the problem. It will reduce or "moderate" economic growth. It will reduce or "moderate" inflation. But cost-push forces will continue to eat away at profits and living standards.

From Marcus Nunes' A last ditch defense of Inflation Targeting:

According to Robert Hetzel, during the period of the Great Inflation, the prevailing view, and the one embraced by Arthur Burns, Fed chairman from 1970 to 1977, was that inflation was a real (cost-push), and therefore non-monetary, phenomenon.

On becoming chairman of the Fed, Volker challenged the Keynesian orthodoxy which held that the high unemployment high inflation combination of the 1970´s demonstrated that inflation arose from cost-push and supply shocks – a situation dubbed “stagflation”.

To Volker, the policy adopted by the FOMC “rests on a simple premise, documented by centuries of experience, that the inflation process is ultimately related to excessive growth in money and credit”.

This view, an overhaul of Fed doctrine, implicitly accepts that rising inflation is caused by “demand-pull” or excess aggregate demand or nominal spending.

 

From the 29th:

So, where Arthur Burns was willing to accommodate the forces that were pushing prices up, Paul Volcker was not.

Before Volcker we had 15 years of worsening inflation. After Volcker we had 30 years of worsening economic growth, attenuated by acts of supply-side desperation and government deficits, leading nonetheless to the system shutdown we call "the crisis".

Yes, you can suppress the quantity of money and thereby keep demand, and inflation, and growth, at a low level. But that does not mean it was demand-pull inflation.

And it certainly does not mean you have solved the problem.


To be perfectly clear on this: I spent a lot of time going over Marcus's post, while writing mine of yesterday. And along the way there was a brief moment when I thought Hm, maybe NGDP Targeting would be better than Inflation Targeting.

Just a brief moment :)

But anyway, that's not the point. The problem in the world today is the cost arising from excessive finance. That cost works itself out as a "cost-push" force, tending to cripple economic growth unless prices increase enough to compensate for that cost.

This cost, which shifts income from the productive sector to the financial sector, is not eliminated by the change from Inflation Targeting to NGDP Targeting. Perhaps NGDP Targeting is a better way to cope with the problem; but it does not solve the problem.

Nor did Paul Volcker solve the problem by suppressing inflation on the assumption that it was "demand-pull". Those cost pressures remain. Those cost pressures bring us to ruin.