Inflation Prospects In An Emerging Market, Like The U.S.

There are two ways to think about inflation in today’s economy.  The first, suggested by conventional macroeconomic frameworks for the US, is that, with rising unemployment and actual output sinking further below “potential” output, inflation will stay low – and we could actually experience the dangers of falling wages and prices (think what happens to mortgage defaults in that scenario).  This is the view, for example, expressed by Fed Vice Chair Don Kohn last week, and the Obama Administration seems to be on exactly the same page – talking already about a further very large fiscal stimulus.

Some people in this camp do see a danger of inflation, down the road, as the economy recovers – and resumes its potential level (or growth rate).  As a result, many of them stress that the Fed will need to start “withdrawing” its support for credit and raising interest rates as soon as the economy turns the corner.  One informed insider’s reaction to our piece on Ben Bernanke in the Washington Post on Sunday was that we were too easy on Bernanke for failing to tighten monetary conditions as the economy began to recover after the last big easing earlier this decade (specifically, our correspondent argues that Bernanke provided the intellectual underpinnings for what Greenspan wanted to do.)

In today’s post-G20 summit situation, some of my former IMF colleagues are worried that further monetary easing around the world will create inflationary pressure in middle-income emerging markets, where inflation is often harder to control than in richer “industrial countries.”  But if you think the broader political and economic dynamics of the United States have become more like those of emerging markets, e.g., the concentrated power of the financial elite and their ability to access corporate welfare, doesn’t that also have potential implications for inflation?

In discussions of emerging markets, you rarely hear discussion of “potential output.”  This is a slippery concept even for the United States, with origins in the idea of running factories at “full capacity” but also reflecting the traditional bargaining power of labor – macroeconomists argue about the exact reasoning but most agree it’s a magical place where inflation is stable.  If output (or growth) is too high relative to potential, inflation rises and, depending on where you are relatively to some sort of inflation goal, the central bank needs to tighten monetary policy in order to bring it down.

Emerging markets traditionally experience big movements in relative prices (e.g., entire sectors collapse), big ups and downs in credit (i.e., regular banking crises and recoveries), and waves of government bad behavior (think expropriation of people’s pensions or other assets).  Potential output simply isn’t stable, or perhaps even measurable, in situations with a lot of investment (in  good times) and much disinvestment or scrapping of capital (when times turn sour).

So what determines inflation in emerging markets?  This is simple, but also very hard to manage: the balance of supply and demand for money.  The government issues money through its financing of budget deficits and various credit-support operations; this obviously tends to push up inflation (i.e., more money tends to reduce the value of money outstanding).  People’s demand for money depends on what they expect in terms of inflation, and this is often affected by what the exchange rate is doing – a depreciating currency both raises the prices of imports directly and moves people’s inflation expectations upwards.  In the background, of course, a growing economy has an increasing demand for money, so the economy can handle – and perhaps even needs – money issue.  In practice, policymakers watch the inflation rate like a hawk and move rates up or down accordingly – but subject to the political pressures coming from higher or lower growth, perhaps relative to their perception of “trend” but without reference to any kind of “potential” concept.

What kind of economy is the US today?  The financial sector has taken a huge hit and is almost certainly going to contract.  The credit system remains disrupted and levels of investment are almost certainly down across the board.  Many firms, nonprofits, and consumers overexpanded relative to what they now see as their more permanent prospects, so there is a big move to “repair balance sheets” (pay down debt; invest less).  Potential output, if that is still a meaningful concept for the US, must be falling; and potential growth (based on some idea of where productivity can go) must also be down.

Even more important in the short-run, inflation expectations are on the move.  There are different ways to think about this (naturally elusive) concept, but take a look at the latest data from the inflation swap market (we’ll do an explainer on this; for now, just look at how expectations have rebounded already from their low at the end of last year; if you want technicalities on this market, try the beginning of this document).  If you prefer to focus on the implied inflation expectation in indexed 10 year US Treasury bonds this stood at 1.4 percent on Friday and shows a similar rebound over the past few months.  (For some reason, my official colleagues prefer bonds; my financial market friends prefer swaps.)

As we explained in our Washington Post article yesterday, we strongly support what Ben Bernanke is doing – there is a lot of uncertainty and the alternatives are much worse.  But we don’t accept the premise that the Fed’s actions today cannot cause inflation quite soon.  Arguing more about this, here and elsewhere, should help us think about how to manage the consequences and minimize the costs.

Excessive inflation is a typical outcome in oligarchic situations when a weak (or pliant) government is unable to force the most powerful to take their losses – high inflation is, in many ways, an inefficient and regressive tax but it’s also often a transfer from poor to rich.

60 thoughts on “Inflation Prospects In An Emerging Market, Like The U.S.

  1. Mr. Johnson:
    As usual, your commentary is profound and raises deep questions about monetary policy and how to fix the financial services mess. This time you also note that one result of the credit crunch is that “potential business output must be down”. Yes, our output is down, but there are also separate systemic reasons that U.S. output has been headed down for a long time, as follows: (1) lack of effective government trade and tax policies to encourage U.S. production of goods and services here, and (2) businesses deciding that profits can be increased by shifting almost any work abroad for cheaper labor. We can and must compete globally, and we can do it without becoming “protectionist”. Both government and business hide behind that phony mantra instead of facing the sorry truth that our trade deficits are unsustainable – that’s the fundamental reason why we’re looking more and more like an “emerging” nation instead of a world leader.
    Ken Davis
    Ken Davis

  2. For over a decade, the first web sites I would visit on the Internet were those of the New York Times and the Washington Post, followed by political blogs like TPM, Dailykos and so forth. In 2009 I start each day with Paul Krugman’s blog and Simon Johnson’s web site.
    Paul Krugman’s pioneering work as a JOURNALIST made a profound difference to millions of Americans. He was the only analyst wise enough and brave enough to call George W. Bush a fraud. He started to do so in 2000 when he could not get Bush’s proposed tax and spending proposals to add up–at all!
    The political economy used to be a subject taught in the finest universities all over the world. Until recently, we have had pale imitations of this discipline in the form of political “science” and mathematics based economic theory. Krugman and Johnson–almost by themselves–are correcting these deficiences.
    How can one understand politics without coming to grip with real world economics? It cannot be done. Yet almost all the talking heads act as though economics is still a subset (and a very small one, at that) of politics. Part of the reason for this, obviously, is that they know next to nothing about real world economics. And, boy, does it show when they write or talk about economics.
    Krugman already has a Nobel Prize. He should get a second and Johnson should get at least his first but in a new category–journalism.

  3. “Watch Switzerland closely. It is tipping into deflation, the first Western country to succumb to Japan’s disease.”

    A different look at the inflation / deflation debate that looks at the effects of currency devaluation on the global markets.

    None of the factors argued by the commentators in their analysis stands alone. All factors must be considered in the analysis of inflation / deflation.

  4. One thing I don’t understand: if inflation is caused by excessive money availability, why didn’t the big lending boom during the housing bubble cause general price inflation?

    In a globalized economy, it seems like excess demand for goods and some services leaks out to places like China, which have large potential workforces. Unless China reverses some of its exchange rate policies, won’t it be difficult for wages to rise here?

    I think the idea of inflating your way out of a debt depends on rising wages. However, if inflation rises without a corresponding rise in general incomes, it will make debts harder to service, just like deflation.

  5. Events of the past couple of years – as well as somewhat earlier, for example the collapse of Long Term Capital Management – demonstrate that it is not just uneducated journalists, but rich and powerful financiers and highly educated and honored intellectuals, who don’t know what they’re talking about, economics-wise. As the mostly forgotten 19th century American writer Josh Billings put it, “It is not so much what we don’t know that gets us in trouble, as what we do know that ain’t so.”

    “Real world economics”, in addition to being a general description of what we would like from an applied social science – that it pays attention to what actually happens – is used as in the title of a free downloadable journal – Real-World Economics Review. See, the webpage of the “post autistics economics” movement.

  6. Mr. Johnson,

    I just saw you on C-SPAN, and while my comments may technically be “off-topic” (the topic being “How I Learned to Stop Worrying and Love Inflation”), this seemed the best place to comment on your C-SPAN appearance.

    You praised Geithner’s purported willingness (as expressed yesterday on Meet the Press) to be “tough” with the banks. I think you’ve entirely missed the point and have followed Geithner’s intentional misdirection. It matters not that bank stockholders have lost a lot of money. Even the forced ejection of current bank executives would be beside the point. The point (and the problem) is that virtually every action taken heretofore by Paulson/Geithner (Peithner?) has had as its primary goal indemnifying bank CREDITORS against any/all losses whatsoever. It’s not about the stockholders – or even the executives – it’s about the creditors and saving them at all cost. That is why $50 billion was funneled through AIG to Goldman Sachs, Deutsche Bank, Soc Gen, etc. paying them out 100% on what should have been worthless “investments” in AIG credit default swaps. There is a good chance that the CDS’s were, in fact, part of a criminal conspiracy to inflate banks’ balance sheets, in order to facilitate the speculative activity that you so correctly criticized in your now-famous Atlantic article. See:!.html

    But whether AIG’s CDS’s were part of a conspiracy or merely ill-conceived, underpriced and misused, the fact is that they were never guaranteed by the full faith and credit of the US government. Nor were investments in CDO’s, MBS’s (even Fannie Mae mortgage-backed-securities) CMBS’s, etc.

    One of the most brilliant parts of your Atlantic piece was the proposition that the big banks be nationalized or put into receivership. You seem to have forgotten that in addition to the fact that receivership would help break up “too big to fail” institutions, it would also allow the banks creditors to be either “haircutted” or potentially wiped out. And that’s a good thing. And that’s a good thing that cannot happen with Hank/Tim Peithner continuing the policy of funneling money to the banks (including via the subterfuge that is the PPIP) for the very PURPOSE of protecting bank creditors. Geithner’s half-hearted (and probably insincere) promise to force a bank CEO or two out of office is merely a head-fake to throw everyone off the scent of his real goal: the continuing protection of bank creditors to the exclusion of virtually everyone else in American society. If GM’s bondholders are going to have to take losses (and they are, big-time), why are we wasting hundreds of billions of dollars to protect the creditors of Citi, Deutsche Bank, Soc Gen & others from taking any losses at all?

  7. This whole debate on inflation vs defaltion in an era of quantative easing (or “credit easing”) tends to be debated by people armed with charts and supposed data to back up their contentions but who forget the most important factor: human nature. We’re supposed to believe that central bankers like Bernanke will “reel in” their current excesses in a few years before inflation becomes a serious problem. It’s akin to “I’ll eat this whole cake now and start a diet tomorrow”. Printing money is addictive. History makes that clear. If we can print $300 billion to buy Treasuries & $1.25 trillion to buy mortgage-backed-securities (as we’re doing now), why not print an extra $3-400 billion every year to fund (fill in the blank): infrastructure, bringing American education into the 20th century, a “smart grid”, conversion of the health care system into whatever it’s supposed to be converted into, shortfalls in social security and medicare, etc. etc. Theoretically we could induce just a little inflation now and stop it just in time. Theoretically you could eat just one potato chip. A quick glance around the shopping mall makes clear that most people will eat the whole bag. Part of the reason the Germans have been reluctant to go whole-hog with stimulus is that they remember the Weimar Republic. Printing money will likely not end well.

  8. Was pleased to hear you “agree with me” that a “simple tax on big-ness” would be a good solution to the TOO BIG TO FAIL problem haunting us all.

    Please comment on the details I posted on March 31 in my blog:

    The problem of “too big to fail” also extends to other entities including governments and political parties. I wish we could make it a general principle of world organization that “small is beautiful”. I am not a “state’s rights” advocate out of a desire to escape majority rule, but precisely because the majority so often has overlooked simpler solutions out of self agrandizement. We should refocus our media and political attention on fixing problems at lower levels and experimenting with multiple solutions throughout the states… clearly, Congress has expanded to the point where they are stupidly “too big to fail” and need to cede some power back to the people.

  9. Simon makes these statements:

    “we strongly support what Ben Bernanke is doing”

    “But we don’t accept the premise that the Fed’s actions today cannot cause inflation quite soon”

    “high inflation is, in many ways, an inefficient and regressive tax but it’s also often a transfer from poor to rich”

    So does Simon support said “inefficient and regressive tax” and “transfer from poor to rich”?

    Maybe it’s because “there is a lot of uncertainty and the alternatives are much worse.” What alternatives are worse? Creditors paying for their mistakes? An end to Fed financed and/or enabled bubbles? A sound economy based on real goods and services rather than fraud in the form of artificially inflated asset prices?

    I’m sad to say that in recent commentary Simon reminds me of Geithner and his recent testimony. When Geithner was told of constituents’ anger, he said “I’m angry too.” So angry that he looks for ways to give them trillions of dollars while trying to hide the nature of the subsidy and all of the game-playing. Empty words.

    This comes pretty close to crazy making and it’s not pretty.

  10. The austrians have a term for the beneficiaries of inflation: early receivers. Guess who they are? The banks, who first get their hands on the newly printed money.

    OTOH, the credit bubble was so big that it appears to my untrained eye to have totally eclipsed our ability to repay in any form, so the inflation necessary to wipe it out will be impossible without End Of The World sorts of events.

    Quite a pickle we’ve found ourselves in.


  11. [I tried a longer post but it (perhaps fortunately) got lost.]

    The real reason Weimar Germany suffered hyperinflation was the Treaty of Versailles.

    Weimar faced crushing debt obligations to pay for the war, and had to print money to buy foreign currency to make payments.

    In other words, hyperinflation resulted from excessive debt obligations that were denominated in a foreign currency.

  12. OK, two serious comments.

    1) Since inflation reduces the real value of debt, does it not primarily transfer wealth from rich to poor, not vice-versa? (I do not think most net creditors are on food stamps.) Put another way, I thought the problem with inflation was that it damaged the free market’s “price signaling” mechanism, which is frankly the only reason free markets are particularly desirable in the first place.

    2) When you do the primer on calculating inflation expectations from swaps, could you explain why there is no arbitrage between the swaps and the TIPS? (I assume there is no arbitrage or the two would have to give the same answer, and so there could be no reason to prefer one over the other.)


  13. In agreement with Nemo… One recent publicly available article with a good lit review on inflation/poor:

    Click to access inflation%20and%20the%20poor.pdf

    The consensus seems to be “it depends”, but on _average_ across many countries and over time, there is a negative correlation between relative income of the poor and inflation.

    However, there are some statistical challenges:

    Notably, there may be reverse causation – that is, inflation is a _response_ to negative economic growth, and the poor tend to suffer more in downturns.

    [This is the same sort of effect that causes a simple regression model to show that hiring more police officers causes an increase in crime rates. Simple time series models do not account for this; you need an instrumental variable model such as that used by Steve Levitt.]

    Also, some work (the Romers) tries to show the impact can depend on where in the business cycle it occurs, but again that over the very long run and across countries inflation is correlated with lower relative income for the poor.

    If one pulls apart these datasets, the story is much more complex. A good chunk of the link between inflation and harm-to-the-poor is driven by a certain type of situation which involves disintegration of the social infrastructure, a corrupt oligarchy, and currency collapse. Russia, Latin American dictators, Zimbabwe, etc.

    We can also point to specific historical scenarios (wage led inflation in Europe in the 60s) where the poor benefited.

    So the questions become:

    Who gets the printed money? (short term, is it the poor or the oligarchs?)

    How does the printed money get used? (investment in growth, or consumption?)

    Was inflation expected? Did the wealthy hedge?

    Is the country at risk of international capital flight, which could increase long term interest rates and stymie growth? (which is especially scary in developing countries)

    Not simple.

  14. Inflation doesn’t transfer wealth from rich to poor. Most lending is done to those with the most capital because it allows that capital to be leveraged–sometimes, as is the case today, greatly so.
    One of the best places to trace effects like this is in early American history. Much of the battle for federal power was between Hamilton and Jefferson. Hamiliton did everything he could to advantage those who were most leveraged–his friends who had bought up revolutionary war debt for pennies on the dollar. Inflation mattered less to Hamilton than Jefferson because the former was most interested in the special interests he represented getting mostly paid back versus getting paid very little or nothing. Had Hamilton not worked to hard to create liquidity, his bond holding friends would have been left holding the bag. Sound at all like those who currently are creditors to banks–the banks’ bond holders?

  15. Switzerland’s devaluation of the franc (not the same!) is the result of an intentional decision by the central bank to devalue the currency- largely as the economists there felt two things: the franc was overvalued compared to the euro and Switzerland, as an exporting nation (yes, they do more than store away bills and gold) would need to make its products more attractive to the eurozone, especially Germany. Switzerland’s main trading partners are using the euro, and the ECB has less control and has also used its weapons less since the crisis. as a result Switzerland essentially had no choice but to devalue.

  16. CJ: “One thing I don’t understand: if inflation is caused by excessive money availability, why didn’t the big lending boom during the housing bubble cause general price inflation?”

    The inflation was limited to residential real estate and, late in the period, energy. This is in large part the reason why it was not recognized by the Fed, which was focused too much on the CPI.

    Another possibility is that the deflationary pressures that threaten us today may have been building for many years, keeping the general price levels from responding to all the excess money in the system. Being just an armchair economist, I’m not sure where to look for the evidence of that.

  17. Hello,

    It seems that current actions of the US Govt are scaring away private sector investment in the capital structure (bonds, preferred, common) of financial institutions. I’ve heard numbers ranging from 5-9 trillion dollars are on the sidelines.

    What would happen if the US Govt started buying common shares of financial institutions on the open market?

    Wouldn’t that encourage the private sector to follow them in, thus raising the price at all levels of the capital structure? Then, at some point, the financial institutions would be able to raise capital by issuing more common stock, with the knowledge that the Govt is a major, consistent buyer and supporter of the price. Wouldn’t a significant portion of that 5-9 trillion dollars come in to support these institutions?

    This would be a win-win-win situation. A win for the financial institutions. A win for investors. And even a win for the US Govt in that their common stock would appreciate in price. The analogy being that of ‘priming the pump’.

    Right now, it seems, the Govt is having to do all the ‘investing’ alone, with little or no help from the private sector. And it’s doubtful that the Govt has the political will to invest what may be required to support these institutions.

    I’ve not heard this approach discussed on any of the TV shows I watch, therefore I am suspicious of it’s ability to work. However I can’t see why it wouldn’t.

    Please enlighten me as to the reasons why this approach may not be viable.


  18. Thank you for the link, Bond Girl. Good paper.

    Hm. They don’t really “address” the arbitrage issue so much as say it should be possible and then give some reasons why maybe it isn’t happening. But only in the U.S., since the differences are smaller for the U.K. and Eurozone (?).

    This may be a stupid question, but… Could the difference boil down to the “floor” in the TIPS CPI adjustment? For U.S. TIPS, the index multiplier never goes below 1 (which only matters if there is deflation, of course). Is the same generally true for the forward swap contracts? If not, then one would expect a systematic difference, especially when deflation is a possible outcome.

  19. My bet is difference in liquidity of respective markets and concentration in specific maturities.

    The paper is an entertaining reminder about how counterparty risk was treated back then.

  20. As a resident of Miami and a long time observer of Latin America, I agree totally with the comparison. While there is some question about causation/correlation, there is no doubt that inequality is correlated with inflation and also corruption. My Latin American friends here in Miami tell me they’ve seen this movie before….

  21. Fielding Mellish –
    Thanks for the comment about the true objective of the FED and Treasury’s policies. Protection of the bond market. Alas, we can not experience recovery until the credit losses are absorbed. Zombie banks and a fiscal deficit at 14 percent of GDP is obviously not the answer.

    engineer27 –
    The adoption of hedonics by the Department of Labor in 1998 has seriously biased inflation reporting in the US. Add to that, massive outsourcing of manufacturing and assembly of consumer goods to emerging markets, and you have a good idea why official inflation appeared to be contained. For the more descriminating, inflation conntinued unabbated due to deteriorating product quality and service.

    Art Hermann –
    What did you get when the US Government subsidized the residential real estate market? The Savings & Loan frauds of the 1980’s, and the Sub-Prime & Adjustable-Rate mortgage frauds of the 2000’s. Fundamentally, the price of stocks should reflect the profitability and dividend distributions of the companies issuing the equities. The market is down right now because the companies are showing losses or low profits. Why would you want to create a bubble in the stock market?

  22. I think everyone in the inflation camp seems to think that somehow the markets are just going to restart because Bernanke wishes so. We’ll “prime the pump” and consumption will just go back to the way it was. Credit markets will flow, and the fancy financial engineers will come “re-pupose” themselves with some new mathematical model – wild guess here – something based on string theory to completely confuse the masses (well, it’s complicated and they’re Ph.D’s – they must know what they’re doing!). Consumers with newfound credit will buy cheap stuff from China, China will in turn require petroleum to produce wonderful and oil will skyrocket to $150/bbl! But all of this BEGS the question – where is this demand going to come from?

    Wages are falling, real estate prices are falling, commercial real estate is going nowhere. You will not see inflation until the unemployment situation fixes itself, and then get a spark in demand.

    But people have been hurt. Pension funds destroyed. The Pension Fund Guarantee Corporation made very BAD bets just as the economy was turning for the worse. Corporations and municipalities have unfunded pension liabilities. 401(k) plans that were to supplement pensions, BECAME defacto pension programs – not the original intent of the law. Municipalities raising taxes, real estate taxes etc.

    Along with this massive restructuring of the financial portion of the United States economy, you just may see social unrest or worse – breakup of the Union.

    Sure, the last sounds wacky, but the economic problems we face are going to cause massive social issues, and if they cascade further along the health and social services networks will be overwhelmed by fires started in this the economic tsunami. People without jobs don’t consume.

    So unless Bernanke has a jobs plan in the works or is going to send everyone checks in the mail or literally perform his “helicopter drops” we will not be seeing inflation for quite a while. No demand, increased savings, unemployment, house prices crashing – none of these are inflationary.

    We are living in interesting times.

  23. @Fielding

    Just a minor point on the comparison to Weimar Germany, which has become a popular reference these days.

    The real reason that Weimar Germany suffered hyperinflation was the Treaty of Versailles, which imposed massive debt on Germany to cover war reparations – debt that was virtually impossible to pay back.

    This debt was denominated in non-local currency and gold, so Weimar had to buy foreign currency, which caused that currency to become more expensive. Yet unlike imports, you can’t just stop debt payments (without defaulting).

    At least, not without the French occupying your industrial region and seizing in-kind payments.

    The US is in a very different situation because its debt is denominated in dollars. It does not need to buy ever-more-expensive foreign currency to pay off debt. It can simply print money and pay it off.

    The consequences of such action are significant, but Weimar-style hyperinflation is not one of them.

  24. Inflation and deflation are not difficult concepts, but tracking them “in reality” is a different story, because their effects are comingled with changes in price due to supply and demand. Examples: Inflation can be masked by cheaper imported goods; deflation can be masked by higher fuel prices due to decreased supplies.

    Inflation is a increase not only in the money & credit supply, but an accompanying velocity (i.e. movement through the (or a) market).

    Where is the credit and money flowing? Is it just replacing what has been “lost”? That is, is it just filling holes? And is that money and credit concentrated in the hands of a few, or being focused in particular markets? All of these things matter in terms of what impact it will have. Are those impacts what “we” want to happen? Do we want to help debtors at the expense of savers? Do we want to bail out the rich at the expense of the less rich? Do we want to save Wall Street (aka Las Vegas East) at the expense of Main Street?

  25. Apparently the land of “Phantom Wealth” is based on the model of The Universe: ever expanding. Who knew all those modelers were in fact astronomers rather than mathematicians. If only someone had told us sooner…

    We are doomed.

  26. Can someone tell me how the Fed destroys money?

    On March 18 2009 The federal reserve stated they will be using “quantitative easing” just printing money ? Shouldn’t this be inflational? Or can we export this inflation to all the bond holder of the USA like China,Japan, Arab oil countries? Do you think the feds are basically devaluing the dollar?
    If so then import prices will increase..

    But how can we have inflation when all the middle class jobs are being cut…california will have an unemployment rate of 12+% by Decemeber. Won’t there be more houses,cars, boats for sale and less demand for everything else? Only basic needs will be the same. Shouldn’t we see deflation on wages and goods until the layoffs subside? I am confused…

  27. If hyperinflation is not a consequence of printing money, then let’s print the living hell out of it. It’s free wealth. We have the Midas touch. Lobster for everyone- breakfast, lunch & dinner.

  28. I can’t back it up with papers or anything like StatsGuy was kind enough to provide, but I’ll take a stab at the general idea behind the poor (really, the laborers) getting hurt by inflation the most:

    The “first receivers” that Carson mentioned above are the entities whom are the first to touch newly created money. You may recall from econ classes that newly created money does not have an immediate 1:1 effect on prices; this is the result of the “first receivers” issue. The receivers — banks, hedge funds receiving TALF/PPIP funding, AIG, etc. — get to spend the new money at old prices which don’t reflect the inflation.

    Next in the chain comes the large corporations who receive financing from the bank. Prices still will not have reacted significantly to the inflation, so they benefit from this as well. Their suppliers will also benefit somewhat, and their suppliers, and on and on.

    The last group in the inflationary food chain are the laborers. Wages are sticky, so laborers can’t expect to have real-time inflation-indexed wages. And, while upper middle class workers may have some negotiating power, less-skilled workers have very little power. As all the players near the top of the food chain begin to adjust to the new money in the system, they will start passing higher prices to their customers, and ultimately to the consumer. The last thing to change will be the laborer’s wages.

    If inflation had instantaneous 1:1 effects on all prices (including the price of labor) it would be fair to everyone. Since it doesn’t, it makes for a good way to manipulate the economy, but does so at the expense of those at the bottom of the food chain. It is absolutely a transfer of wealth.

  29. “The consequences of such action are significant…”

    The lack of Weimar-style hyperinflation does not mean that printing money has no consequences. We may see inflation of 15%… which has consequences, but 10,000% we will not see.

    Generally speaking, however, the concern is that printing money will _eventually_ cause severe inflation when velocity kicks back in, and the Fed won’t have the tools or willpower or foresight to prevent this.

    This can be prevented by permanently increasing global capital-asset ratios (reducing leverage globally) so that when the trillions in cash move off the sidelines, it doesn’t get levered back up to Y2006 levels of insanity.

    In other words, shift the entire system to more cash, less debt.

    And one final point:

    Lobsters are arachnids… only 2 steps removed from giant underwater tarantulas. Ick.

  30. A few:

    1) Increase Fed Funds rate

    2) Have Treasury sell Fed assets… the “investments” in banks – force these to be replaced by private capital. Hopefully private capital think those “investments” are worth something.

    3) Cut or reduce programs that directly expand the Fed balance sheet, such as the program to buy short term collateralized private paper. Fed could either wait for the paper to come due and accept payment, then refuse to issue new paper… or it could directly sell paper on the open market.

    According to the balance sheet, it looks like the Fed could quickly suck out 1-1.5 trillion dollars directly.

  31. for what it’s worth, households’ long-term inflation expectations do seem to be fairly stable. the University of Michigan survey data on this are harder to get now that Reuters has rights to the recent months’ survey results, but what I’ve read in the news doesn’t indicate any take-off in long-run expected inflation — indeed, it might have fallen slightly from 2008Q4.

    And I think this is one measure the Fed likely studies. my guess is that the Fed will downplay concerns about accelerated inflation unless wage earners start to increase their expectations of inflation, after which they will (presumably) build those increases into expectations of future nominal wage increases.

    where does this leave the swap and TIPS data? financial-market-based measures of expected inflation do tend to move around a lot more than survey responses. could the recent fluctuations in financial market measure be more noise than signal?

  32. “So what determines inflation in emerging markets? This is simple, but also very hard to manage: the balance of supply and demand for money.”

    Thanks for saying this – there isn’t much talk about demand for money these days, for some reason.

    One point though: isn’t the balance between demand and supply for money a determinant inflation in all economies, emerging or otherwise?

  33. Mr. Johnson,

    Your conclusion is correct, but would your analysis change if you consider inflation is currently almost 8% when calculated in the same way as in 1980? See:
    Read the August 2006 SGS newsletter linked there for the dry details of how and why it was falsified.

    The falsification of the inflation number is the driving force behind your statement:

    “Excessive inflation is a typical outcome in oligarchic situations when a weak (or pliant) government is unable to force the most powerful to take their losses – high inflation is, in many ways, an inefficient and regressive tax but it’s also often a transfer from poor to rich.”

  34. MarkS,

    Thanks for the comment. You are right if the current stock price of financial institutions correctly reflects the real value of these institutions.

    However, I’m thinking it’s very likely that the value of ‘many’ of these financial institutions is much greater than what is reflected in their stock price.

    If that is the case, then the kind of Govt intervention I suggest, instead of further depressing common stock prices, would help return them to a proper level.

    Again, thanks for the comment.

  35. WHO WAS IN CHARGE OF THIS MESS????? Simon?????

    DUSHANBE, Tajikistan (AP) — A chairman of Tajikistan’s Central Bank diverted more than $850 million to a company run by himself and his family, according to an independent audit posted on the bank’s Web site Monday.

    The Ernst & Young audit said that under Murodali Alimardonov’s stewardship, from 1996 to 2008, the Central Bank paid about $856 million to his Credit-Invest company, a general purpose investment concern. According to the audit, a further $221.5 million allocated for investment in the cotton industry in 2004-2007 remains unaccounted for.

    Gross financial irregularities are common in the former Soviet nation, which borders China and Afghanistan in central Asia. The International Monetary Fund last year demanded repayment of $47 million in loans amid charges that Tajik authorities doctored data on national reserves.

    However, the sums of money allegedly appropriated by Alimardonov, who has served as deputy prime minister in charge of agriculture since leaving the Central Bank job last year, are enormous for the impoverished nation, whose economy has been wracked by severe power shortages and lack of investment.

    According to Ernst & Young’s report, government loans were issued to Credit-Invest for the development of the cotton sector, but were later used for unrelated business initiatives. In one instance, $800,000 was spent on building a restaurant in the northern Tajik city of Istaravshan , the report said.

    Tajik authorities agreed to the audit of the Central Bank and other major state enterprises in the wake of the IMF scandal. However, Ernst & Young said many of the documents needed for its investigation were destroyed prior to the audit.

    Government officials refused on Monday to comment about the findings of the audit

  36. I am puzzled. It seems to me inflation is the only way out of this mess. Only high inflation is going to push up housing prices. Only high inflation can make the debt levels people took on tolerable. What is needed is a wage price spiral that makes homes affordable and those debt payments manageable.

    What am I missing?

  37. Ross, you are mostly correct that we need some inflation to help the situation, but the real concern is hyper-inflation where you need a wheelbarrow instead of a wallet to carry your money.

    The other aspect is that there was a “hidden” inflation created when Greenspan faked the CPI calculation to “fix” Social Security. From the site it appears the “hidden” inflation has been 8% or more above the official CPI number for more than a decade.

    In other words, if the government claims inflation is 3%, you expect wages to go up about 3% instead of the the 11% more likely inflation number. Then you can’t understand why you keep going in the hole and need to refinace your house to cover expenses. Instead or gaining in wealth with the appreciation in value of your home you are borrowing it and the finance sector gains income for lending to you.

    Interest rates are kept low because the Fed does not increase it’s rates when the “official” CPI is 3%. Consider what interest rates would be if the official CPI was 11%. This is what is being referred to when the experts refer to the era of “easy money” or “cheap credit”.

    The above process is what Simon Johnson was referring to when he stated:
    “Excessive inflation is … an inefficient and regressive tax but it’s also often a transfer from poor to rich.”

    Until this is corrected any inflation increase will mask the recession but also accelerate the transfer of wealth from the lowest 95% to the wealthiest 5%.

    It is easy to see why the super-rich, the financial industry, and politicians are heavily invested in keeping this system going. It is intellectually dishonest and morally repugnant for any expert to discuss “inflation” without at least mentioning they are using intentionally falsified numbers to draw conclusions.

  38. You are correct. That is the intention of the Treasury and the Fed. That is the mathematical model we’ve thrived on for decades. However, small businesses and corporations are not going to be handing over hefty raises any time soon.

    Unemployment is accelerating. That is wage deflationary, even if the incomes of those employed remains static.

    Municipalities are asking more from taxpayers (at least here in NY) in property, fees, tolls, public transportation. At the same time the public isn’t spending discretionary income as the fear exists there may be no job (hence no cash) for living expenses. That is deflationary.

    Housing price decline. That too is deflationary, as it was a substitute for static/low rising wages. Home equity wealth was withdrawn and used for consumption (vacations, cars, flat scree TV’s). HEW is now gone, and the wealth effect from that era has been spent.

    Other than praying that it becomes so, how would you expect a wage or price spiral in the shadow of falling job numbers, falling home prices, falling capital production utilization (currently at 65% IIRC, – apology but don’t have a link handy).

    Unless Ben Bernanke launches his cash filled helicopters and begins dropping it in the publics hands, there will be no inflation. Japan has tried and has failed. I think they’re at 190% plus DEBT to GDP….

    When the map (link to article below – interactive map of vanishing employment across the country) begins to turn blue again, that’s when you’ll get your inflation. Don’t hold your breath.

    I must say .like the Chinese say, we ARE living in interesting times!!!!!

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