Thursday, December 11, 2014

Boiling it down a little too much


Image Source: Dr. James G. Wellborn


Marc Thoma, via Lars P. Syll:
It’s the time of year when analysts and pundits begin “marking their beliefs to market” – telling us what they got right or wrong in the previous year. In that spirit, here are some of the things I got wrong about the Great Recession...

The lesson for me is that if you want the inflation rate to increase, demand has to increase. That requires more than simply creating a bunch of reserves that sit idle in banks.

//

Listen carefully to Milton Friedman in Free to Choose:
When a country starts on an inflationary episode, the initial effects seem good. The increased quantity of money enables whoever has access to it -- nowadays, primarily governments -- to spend more without anybody else having to spend less. Jobs become plentiful, business is brisk, almost everybody is happy -- at first. Those are the good effects. But then the increased spending starts to raise prices...

Catch that last bit? It is spending that influences prices, not the existence of money. That's what Friedman said.

If anybody thought inflation was caused by printing money, I guess they boiled the idea down a bit too much.

5 comments:

The Arthurian said...

ps,
By "anybody" I don't mean Marc Thoma. In the quote at Syll's, after Thoma says "here are some of the things I got wrong", and before he says "The lesson for me is that if you want the inflation rate to increase, demand has to increase", he says this:

... I thought central banks could create inflation pretty much at will... All that was needed was to crank up the printing press, [and] get the money into the hands of people who will spend it...

Thoma knew.

Auburn Parks said...

I always put it like this:

"If the Govt gave me $1 trillion and I never spent a single penny of that money, and my kids and grandkids never spent a penny of it either, can it cause inflation?"

The obvious answer is no, savings cannot cause inflation only spending can. Which is why taxing millionaires (progressive taxation) more to fund middle class spending programs is an ineffective way to battle inflation.

The Arthurian said...

Auburn, I remember you said something to that effect before. We think alike on this, you and I and Thoma. And Friedman.

Gee, I wonder why those excess reserves didn't cause inflation.

Interesting conclusion. But does anyone claim that progressive taxation helps to fight inflation?

Auburn Parks said...

"Interesting conclusion. But does anyone claim that progressive taxation helps to fight inflation?"

Only in the sense that people think large deficits cause inflation and so to reduce inflation you should reduce the deficit. When its a little more complicated than that.

For example:

Say we have full employment (2%???), and a $1 trillion deficit at T-0.
And over the course of the year, we experience increasing inflation. Now say the response is to increase taxes by $500 Billion to reduce the deficit and thus the inflation (as opposed to cutting spending).

Which of these two scenarios would better combat inflation:

1) raising FICA taxes by $500 billion?

2) Raising taxes on the .01% ($9 million+ yearly income)?

http://www.ritholtz.com/blog/2011/10/forget-the-top-1-look-at-the-top-0-1/

Its pretty obvious that a progressive tax increase at full employment (#2), would have less of an downward impact on inflation than a flat tax increase on every wage earner (#1).

Its really just the reverse logic of why cutting taxes on millionaires doesnt stimulate the economy as much as cutting taxes for the working class

The Arthurian said...

Come to think of it...

Auburn Parks: "... taxing millionaires (progressive taxation) more to fund middle class spending programs is an ineffective way to battle inflation."

Maybe that's why people who focus on inflation as the problem also tend to oppose progressive taxation. It doesn't solve the problem that concerns them.

Interesting.