I'm wondering why people even bother to teach cost-push inflation. I mean, the prevailing attitude is that there's no such thing: Prices go up because there's too much demand, period, end of story.
To me, that's plain ignorance. But that's easy for me to say, because I don't know anything. I had just one three-credit course in economics -- you know, ECON 101, the one economists use as an example when they make jokes about people not understanding economics. Yeah, that. From my vantage point, knowing so little, it's easy to see when people are brushing questions aside thoughtlessly.
Ignorance is an attitude.
Marcus Nunes on Paul Volcker
In an old post (but one that fascinates me more than ever) Marcus Nunes writes
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.
... This view is clearly illustrated by Burns who argued as early as 1970 that “monetary and fiscal tools are inadequate for dealing sources of inflation such as are plaguing us now – that is, pressure on costs arising from excessive wage increases”.
... This view is clearly illustrated by Burns who argued as early as 1970 that “monetary and fiscal tools are inadequate for dealing sources of inflation such as are plaguing us now – that is, pressure on costs arising from excessive wage increases”.
There follows an explanation of "a flawed forecasting mechanism" involving the Phillips curve -- again, absolutely fascinating.
Next, Marcus describes the policy change that a change in leadership brought to the Fed:
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.
... 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.
Essentially, Paul Volcker said there's no such thing as cost-push inflation. And that was all there was to that.
Josh Hendrickson on Paul Volcker
In an even older post, Josh Hendrickson at The Everyday Economist writes
Relying on public statements and personal diary entries from Arthur Burns, I demonstrate that there is little evidence that the Federal Reserve was less concerned with inflation during the 1970s. Rather, the view of Burns and others was that inflation was largely a cost-push phenomenon...
The shift in policy, beginning with Paul Volcker, was an explicit attempt to stabilize inflation expectations and this was done deliberately at first through monetary targeting and ultimately through the stabilization of nominal income growth. Gone were notions of cost-push versus demand-pull inflation. The Fed simply assumed accountability as the creator of inflation.
The shift in policy, beginning with Paul Volcker, was an explicit attempt to stabilize inflation expectations and this was done deliberately at first through monetary targeting and ultimately through the stabilization of nominal income growth. Gone were notions of cost-push versus demand-pull inflation. The Fed simply assumed accountability as the creator of inflation.
The solution to the problem of cost-push inflation was to dismiss the whole idea of it. Essentially, Paul Volcker said there's no such thing as cost-push inflation, and that was all there was to that.
Among the comments on Hendrickson's post is one by Marcus Nunes, linking to an older version of his post quoted above.
In other comments there, Nick Rowe quoted Josh Hendrickson
Josh: “Rather, the view of Burns and others was that inflation was largely a cost-push phenomenon...”
and replied:
People forget (and maybe younger people never knew) just how common that view was in the 1970’s. It was common among economists as well as the general population. It was almost the orthodoxy of the time, IIRC. Tighter monetary policy would just raise interest rates, which would increase costs, and make inflation even worse.
Hendrickson replied to Nick Rowe:
Yes, you are correct. I make the point in the paper that Burns’ view is consistent with the orthodoxy of the time...
Bill Woolsey also replied to Nick:
There were really _economists_ who thought that “tighter money” would raise inflation through a cost-push mechanism?
There were such economists. Bill Woolsey is evidence of just how thoroughly cost-push as a legitimate economic concept has been purged from economic thought.
The cost-push problem was never solved. It was dismissed. It was purged from economic thought. If there is no such thing as cost-push inflation, that's okay. Otherwise it's a problem.
Me, I still remember Wesley.
Arthurian Theory
The factor cost of money was increased by persistently increasing the reliance on credit -- what most people call the growth of debt. The growing cost of finance hindered economic growth, such that the choices open to policy were:
a) reduce the hindrance by expanding the money, thus creating inflation, or
b) accept the hindrance and accept that economic growth would be slower going forward.
Arthur Burns followed option "a". Paul Volcker went with option "b".
I call for option "c": Reduce the reliance on credit.
Many people today call for 100% reserve banking. That's the extreme form of reducing the reliance on credit. Too extreme, I think.
Let us create tax incentives that encourage the repayment of debt, and use these incentives in place of the existing incentives that favor debt accumulation (like the tax deduction for interest expense). Today, the playing field is tilted toward increasing the accumulation of private debt. We must tilt it the other way, toward reducing the accumulation of private debt. Then, if we want, we can sit back, put our feet up, and wait.
3 comments:
From the post: "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”."
Milton Friedman, from Money Mischief Chapter 8: The Cause and Cure of Inflation. Under the heading "The Cure for Inflation":
"The cure for inflation is simple to state but hard to implement. Just as an excessive increase in the quantity of money is the one and only important cause of inflation, so a reduction in the rate of monetary growth is the one and only cure for inflation. The problem is not one of knowing what to do. That is easy enough -- government must increase the quantity of money less rapidly. The problem is to have the political will to take the necessary measures."
The "one and only" cause of inflation, Friedman says, and "the one and only cure". There's not a lot of contemplation going on there. Just forceful announcements. Hey I know, I often do the same thing on the topic of debt. But I like to think I have an open mind and that if you can make a good argument to get me to doubt my view, I just might change my thinking on debt. With Friedman, there was no such flexibility.
Now, what if there is not just "one and only one" cause of inflation? People used to say there were two kinds of inflation: Demand-Pull, and Cost-Push. Friedman and Volcker thought all inflation was demand-pull, and that there was no such thing as cost-push inflation. But what if they were wrong?
If we had cost-push inflation, you could stop it the same way you stop demand-pull inflation: by reducing the rate of monetary growth. Because if the money's not there, the prices will have difficulty to go up.
That solution, however, does not address the cost problem. If there is a cost problem driving prices up, and you solve it by slowing the growth of money, you have not solved the cost problem. The cost problem remains, eating into business profits and sapping the living standards of consumers. We had such problems, during the 1970s and since.
[continued]
And then we started changing the economy, creating supply-side policies and such, to make business better and, you know, create more jobs. And some businesses have done extremely well, though many have not. And some consumers have done really well, though many have not.
It was the wrong solution. We pretended there was no such thing as cost-push inflation, and we used the demand-pull solution. And inflation did come down because prices have difficulty to go up. But inflation never got as low as it should have, and growth never got as good as it should have, because we used the wrong solution. And to this day prices have difficulty to go up but they do go up, and the economy has many other difficulties besides.
And what about the "simple premise, documented by centuries of experience, that the inflation process is ultimately related to excessive growth in money and credit"? It's true, I think. But the economy changes.
Does this make sense: The economy changed, and something that was true for hundreds of years suddenly stopped being true? As it stands, maybe not. Maybe I would want to say that the economy changed because of our economic policies. The policies created unnatural economic forces and the economy changed in unnatural ways.
That's why, when they were confronted with this problem, Friedman and Volcker and others of their generation did not understand the problem. They accepted the centuries-old premise that excessively rapid money growth must be the problem, because there was no other explanation. But they created another explanarion when they created the policies that turned our economy into one based on credit rather than money. They turned financial cost from something small and ignorable into something unnaturally large and costly.
After the second World War, policymakers knew that using credit was good for economic growth. And they started creating policies to get us using more credit, and to make credit more available. But policymakers never finished the thought. They never worried that using more credit would create more debt. They never worried that, just as using credit gives the economy a boost, paying back the borrowed money would have the opposite effect and slow the economy down. They didn't think about that.
Or maybe they did think about it. Maybe they realized there would be an added bonus: Along with the increase in debt and credit use, there would be an increase in financial wealth available to those who could afford to own it. You know: senators and people like that.
What they were thinking, I can't know. But what the problem was, and how they misread it, I do know. And now you do, too.
In the above post I used a quote that Marcus Nunes attributed to Paul Volcker:
“rests on a simple premise, documented by centuries of experience, that the inflation process is ultimately related to excessive growth in money and credit”
I have now found the source of that quote. It can be found on page 962 of a Congressional Hearings book, among the Google Books. Here is the link.
Again:
https://www.google.com/books/edition/Hearings_Reports_and_Prints_of_the_House/ONQ1AAAAIAAJ?hl=en&gbpv=1&dq=rests+on+a+simple+premise,+documented+by+centuries+of+experience,+that+the+inflation+process+is+ultimately+related+to+excessive+growth+in+money+and+credit&pg=PA962&printsec=frontcover
The quote is from a speech given by Paul Volcker to the National Press Club in Washington, D.C. on January 2, 1980. The speech can be found at FRASER on page 4 of 12 (which is numbered as page 3 in the document).
https://fraser.stlouisfed.org/title/statements-speeches-paul-a-volcker-451/remarks-national-press-club-washington-dc-8210
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