May

14

 It is time we get our heads out of the sand and stop subtracting out food and energy and admit we have an inflation problem. Energy prices are up and are going to stay up. It has been going on for two years and we (the Fed) must stop fooling ourselves into thinking there is only transient inflation which will likely reverse itself and that there is no core inflation. The transient is now permanent, though volatile. We really have an inflation problem.

Michael Cook writes:

I disagree that we necessarily have an inflation problem just because energy prices are up and are going to stay up. The fact that they are up is sending a legitimate economic signal that supply and demand are not in balance, similar for food. Were the Fed to choke off this "inflation" by throwing us into a recession, these price signals would not be able to do their work of drawing out competitive supply in the form of nuclear, solar, biofuels, fuel cells, etc. - whatever the creativity of entrepreneurs comes up with.

Jim Sogi writes:

The other unidentified variables are the global currency/capital flows that render the "island model" obsolete. There are a number of well-tested empirical theories and studies. But early into the floating currency regime the dynamics are not well understood. There are various theories.

Productivity, things like hours per week are one measure. Other tested theories include comparisons of monetary conditions, fiscal policies, economic growth, central bank policies, portfolio balance, purchasing parity (McDonald's indicator) that seek to predict currency flows. The size of these capital flows are so significant as to render traditional measures of domestic economic conditions no longer reliable or as predictive as they were. Ignoring these variables is a mistake.

Charles Pennington adds:

This argument has been made repeatedly, but is there any empirical basis for it, or any rigorous theoretical basis?

Can it be stated in a falsifiable way, such as the following:

"If money supply measure X (M1? M2? M3? something else?) increases by Y percent, then price index Z (CPI? PPI? sum market caps of stocks, bonds, real estate?) will also change by Y percent."?

My understanding is that history shows that there are times when the value of "everything" drops or increases, without any change of comparable magnitude in the various measures of money supply.

The market cap of the U.S. stock and bond markets add up to about $30 trillion. For just residential real estate, I find numbers that are a few $10s of trillion. Meanwhile the most liberal definition of money supply has it on the order of $10 trillion.

From say 1995 to 2000 the stock market more than doubled, and real estate went up, too. Just the changes in value of stocks and real estate over that period clearly add up to more than the entire money supply. Prices of other things, in general (as measured for example by the CPI and PPI), certainly did not go down over the period. So it appears to me that there can be massive repricing of things in general, of magnitude that dwarfs not just the change in money supply (about $2 trillion over that period), but the money supply itself.

This tells me that pricing of things in general has pretty wide latitude to move around. The value of "everything" dwarfs all measures of money supply, and makes moves of magnitudes that dwarf changes in the money supply. One should never think of there being some kind of grand conservation law, though I'm sure there are useful correlations. 


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