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Inflation and its causes

In your current post, "Understanding Government Liabilities" you state that government's most important function vis a vis the economy is to not create excessive inflation.  Yet in a prior post you stated that no one understands the causes of excessive inflation.

Please explain the apparent contradiction.

Thanks

Hi @sheldon-kay

We have approximate understandings of what causes inflation (too much money chasing too few goods, rising wages, demographics, etc etc). But we don’t have a precise model for it. That’s what I mean when I say that no one really understands exactly what causes inflation.

This doesn’t mean the govt can’t try to manage what it controls along the way.

Hope that helps clarify.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

We've increased the money supply and, prior to the pandemic, had full unemployment, both of which should have increased inflationary pressures.  Yet we've had deflationary tendencies for the last 20 years.

What would you recommend the government do as a check against inflation?

I think the USA does a pretty good job overall. The evidence of the last 20 years speaks for itself. The Fed is pretty strict about maintaining a 2% inflation target and they tend to get pretty concerned above that. It’s been a pretty effective approach so far....

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Frances Coppola had a couple of interesting pieces on inflation back in 2019.

https://www.coppolacomment.com/2019/03/why-central-bankers-dont-understand.html

 

https://www.coppolacomment.com/2019/03/inflation-is-always-and-everywhere.html

I agree,  inflation has remained low, and that is my puzzle.  Government controls the money supply through fiscal and monetary policy.  Money supply is considered, by traditional economics, a major factor, if not the major factor, causing inflation.  Over the past 20 years the money supply expanded at a much faster pace than the prior 20 years.  Yet there has been no inflation.  If anything the tendency over the last two decades has been deflationary.

So there is something wrong with the traditional understanding of inflation.  What is your understanding of what is going on?

Cullen, from your post: that was a nice example, buying a hamburger vs buying an asset. Uncle Sam's buying military equipment, aircraft are like "hamburgers". These are things that eventually go to crap, and are consumed, may be recycled. Whereas investments in infrastructure have enduring value/inherent value (and upkeep costs). Why o' why is the money spent on these assets counted in our National Debt. If the current value of all the assets Uncle Sam has bought, and built over the century is added up, we don't have a National Debt at all. We are soooo in the green it's amazing. That is why we are by far the richest country in the world. Please, add this to your analysis.

 

Because it is a debt acquired.  The enduring value of these assets is reflected in the increased GDP over time.  So our governments current debt level is a consequence of living beyond its income.

Think of the cost of education financed by debt.   Presumably the training of the mind lasts well beyond the four years or so of time in college and leads to an increase in income, which more than offsets the college debt incurred.  Whether the debt is paid off depends on whether the individual lives above or below his income level.

Hi @dennis-kleid

Yeah, that's a debate I have with people very often. Govt spending has a huge multiplier effect especially when it's geared towards things with a high NPV. The US govt is especially good at this because they mostly partner with private firms that leverage their strengths as private sector firms.

Of course, there are wasteful forms of govt spending, but we shouldn't dismiss all govt investment just because some components of it are poorly targeted.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

I agree Cullen the properly targeted government spending in partnership with the private sector can have large long lasting positive impact on the economy.  Unfortunately in recent decades that rosy scenario has not played out well.  I am mindful of the huge cost overruns and the long delays in completion of the big dig project in Boston and the expansion of the 405 freeway in Los Angeles.  In the latter case, the expansion of the 405 did little to ease the freeway's congestion.

These projects are highly impacted by the multitude of regulatory hurdles needed to jump over to begin and continue construction.  15 years ago President Obama declared there were many shovel jobs available for the then unprecedented stimulus size of close to 800 billion dollars.  President Biden's takeaway from  that failure, the cure to government failure is larger government spending.

This new 2 trillion, so called,  infrastructure bill, should it pass, will be a test of the effectiveness of big government.  It will also be a test of economic theory regarding inflation, and of the Fed's ability to control inflation should it ignite because of the unprecedented increase in the money supply.