-->
Courtenay email -
Welcome to this month's edition of Ask the Professor. We are pleased to once again have with us Steven Horwitz, Charles A. Dana Professor of Economics at St. Lawrence University in Canton, New York. Please remember to regularly refresh your browser throughout the discussion to see the latest comments.
Alan Forrester email -
You say that central banks "are likely to err on the side of inflation not deflation in order to please their political overseers." Why do politicians want inflation or policies that lead to inflation?
Great question. There are a couple of reasons.
1. Inflation transfers resources to the inflator, in this case the government. Inflation allows politician to spend the new dollars into existence on their favorite programs, esp. though likely to get votes.
2. Inflation reduces the real value of debt because the debtor pays back in dollars that are worth less than those they borrowed. Governments are HUGE borrowers, so inflation reduces the real value of government debt, which also creates room for governments to spend more.
Justin Bowen email -
As I understand it, during the Clinton administration the calculation used to determine inflation (or what the government would define as inflation) was changed. The new calculation excluded energy, food, and housing costs.
Could you explain why those inputs should or should not be important to the government when it calculates inflation?
Also, I have heard people speculate that the reason the government decided to make new calculations for inflation, unemployment, and other economic data, or at least part of the reason, was to lower the amount that those who receive government checks will ultimately receive by lowering the cost-of-living increases that are provided every year and thereby shrink the portion of the federal budget attributed to those costs. Whether or not this was the actual reason for why they came up with a new way of calculating inflation and unemployment, is this the actual effect?
Prof. Horwitz writes:
What happens now is that there are normally two inflations rates that are reported. "Core" inflation which excludes those items and then the overall inflation rate which INcludes them. The reason for separating them is that, as we've seen in recent months, those prices can be highly volatile, so that short-term movements in them can vastly overstate or understate the longer-run inflation rate. Reporting both makes some sense in that way.
Again, they didn't replace one with the other; they report both. As I understand it, the benefits are still based on the more comprehensive number.
Justin Bowen email -
If inflation is a monetary phenomenon, why doesn't it appear to keep pace with the increase in the money supply (or am I wrong about this)?
Prof. Horwitz writes:
This is a great question and takes us a little deeper into monetary theory. There are two reasons:
1. It's not the money supply per se that matters but its excess over the demand to hold money. So the money supply can go up but if the demand for money rises just as much, there will be no inflation as the additional money is not entering the spending stream.
2. Other factors can affect the price level, such as we're seeing with oil prices in recent months. Those changes in the price level aren't inflation in the technical sense, rather they are just reflecting the fact that this one resource is now more scarce. So the money supply and the price level need not track 1:1 for there to be inflation. It depends upon both the degree of excess in the money supply and those other influences on prices.
Econ101 email -
Prof. Horwitz,
Is there an appropriate role for central banks? What is that role?
Thanks
Prof. Horwitz writes:
This is a matter of some debate among economists who generally favor free markets. For some, a central bank is not a problem as long as it sticks to a publicly announced clear rule that guides the growth rate in the money supply. For these folks, the problem is when central banks exercise too much discretion.
Other free market oriented economists argue that there really isn't any need for a central bank as individual banks already produce most of the money supply (via checking accounts) and if we gave them the power to issue their own currency (as was common in the US and Canada in the 19th century and before), and those were redeemable in some commodity (gold perhaps), the money supply would better track money demand and inflation and deflation would be avoided. For this group, central banks cause much more harm than good.
Again, this is a much-debated issue and I'd be happy to provide some links to readings if you wish.
Aaron Hajdu email -
Are central banks and governments essentially passing on the cost of their debts to the general population via inflation?
Prof. Horwitz writes:
I think that's one way to look at it. Ultimately, we all pay for government debt one way or another. The more government borrows, the less there is for the private sector to borrow, so we pay a cost in terms of foregone private investment and the benefits it brings. In addition, "we" pay the interest on the debt through taxes and if one assumes the debt will eventually have to be paid off, we'll pay for it that way as well.
What inflation does is to pass the costs of the debt on to the *current* generation by implicitly transferring resources from us, through higher prices, to government, in the form of the lower real value of the debt.
"We" always bear the costs of government debt, but inflation puts the burden on the current generation and does it in a sneaky, haphazard way.
Econ Sean email -
I read in the paper recently that the currency in Zimbabwe is inflating at a rate of over 11 million percent! And they are apparently continuing to print money to SAVE the economy? Why would they do this - does it ever work?
Prof. Horwitz writes:
They are doing this because they are crazy. :) Somewhat more seriously, once governments get caught in an inflationary spiral, the only way for them to stay ahead of it and keep power is to keep printing more money and making inflation run ahead of expectations. If they stop, the economy will quickly collapse. If they keep printing, it will collapse but just more slowly. What's happening there is not rational in any economic sense: it's the regime desperately trying to keep its power.
annie email -
You mentioned some links to readings on the central bank issue. I would like to read more about the disputed role of central banks. Thanks.
Prof. Horwitz writes:
Here's a page full of links on the idea of "free banking" and related ideas. It's from the webpage of Larry White of the University of Missouri - St. Louis who is one of experts on the topic:
http://www.umsl.edu/~whitelh/links.html
Many of those essays discuss the various controversies.
Greg Krewski email -
The term "stagflation" was coined in the 1970s, apparently to describe an unprecedented phenomenon. Assuming this was a new development, do you see the signs of stagflation re-emerging soon?
Prof. Horwitz writes:
I'm not sure it was "unprecedented" as much as it didn't fit the then-orthodox belief that inflation and unemployment were inversely related. When we got both at the same time, it didn't fit the Keynesian theoretical framework. The result was, eventually, the demise of Keynesianism.
As for now, no I don't really see it re-emerging. The US economy anyway is actually fundamentally sound. GDP grew at 3.3% last quarter and unemployment is at 5.7%, which would have been considered wonderfully low 15 years ago. Yes, inflation is up a bit, but we're hardly seeing stagnation elsewhere. And it will be interesting to see what inflation looks like with oil prices coming back down a bit. In any case, I'm not immediately concerned about stagflation recurring.
Jason Kneely email -
You mentioned that inflation hits different goods and services in an unpredictable chronology. But if inflation happened in a particular economy once, wouldn’t a second incident have a predictable order of price increases? Or perhaps one could make a prediction in a similar economy (i.e. if the index of their stock markets had a positive correlation of close to 1)
Prof. Horwitz writes:
Not necessarily Jason. When new money enters in, it is through financial markets as government bonds are sold to the Fed. The path that the new money takes depends on who sells those bonds and who they lend their new funds to, and where those people spend the money, etc.. There's no reason to believe there would ever be any sort of exactly similarity between the paths that two injections of new funds take. Each inflation takes a different course through the economy. Yes, there might be some broad parallels, but only at the more general level.
Dave email -
In addition to what Econ Sean wrote - What would happen then if they stopped printing money completely in Zimbabwe? Would it really be worse than if they keep on printing it to delay the inevitable?
Prof Horwitz writes:
If you were diagnosed as having swallowed a poison, and you knew that if you did nothing it would eventually kill you but that if you took an antidote now, you'd feel really really awful but survive, what would you do?
If you're a ruler in power, you might well choose to wait hoping against hope that it wouldn't kill you and that you'd keep your power. But if you're the citizenry, isn't some short term pain worth starting fresh?
Courtenay email -
Very interesting chat so far, everyone. We only have 15 minutes remaining, so if you have any more questions or would like to respond to one of Professor Horwitz's answers, please do so now.
George MacArthur email -
How can you tell if a price is inflated or if it went up in response to higher demand? Are there any ways to tell?
Prof Horwitz writes:
Not with certainty. You'd need to know what was happening in that particular industry, you'd need to know what was going on with the supply and demand for money, and you'd need to know, and this is the hard part, how the excess supply of money worked its way through the economy. Bottom line - you can make a general guess but you can't ever know for sure.
And this is one of the real problems with inflation: firms just don't know if they are seeing "real" increased demand for their product or the effects of inflation. This confusing signal can lead them to make bad choices as a result, and those can have real costs to the economy. It's hard enough for entrepreneurs to figure out their markets, and inflation just makes it that much harder.
Courtenay email -
A big Thank You to Professor Horwitz for joining us today. This concludes our discussion on inflation. Thanks for your participation in this month's chat. Please join us next time on Monday, September 29th at 11:00am Pacific when we will discuss unemployment.
Paul Jackson email -
I often hear, as stated in the above article on inflation, that if for example, gas prices rise sharply, the prices of "other goods" will fall as people spend less on them. Is this actually tracked? I mean, are the consumption rates and prices of these "other goods" actually followed to see if in fact they fall as you claim they will. What is your methodology for ensuring that this is an accurate view. You are also not taking into account peoples use of credit cards and lines of credit. With personal debt rates rising rapidly, is it not possible that people continue to consume these "other products" regardless of rising prices of the commodities they need on a daily basis?
Dr. Horwitz writes:
One could look at components of the consumer price index in the US to track this kind of activity. The question back at you is: if people spend more on gas prices rise, where is their ability to spend that additional money coming from? Two choices: debt (which I'll respond to below) or reducing spending elsewhere.
You are also not taking into account peoples use of credit cards and lines of credit. With personal debt rates rising rapidly, is it not possible that people continue to consume these "other products" regardless of rising prices of the commodities they need on a daily basis?
It's certainly possible that they are financing the higher gas expenditures by running higher credit card balances. But keep opportunity cost in mind: the real resources that the credit card issuer uses to pay the merchants have to come from somewhere. If I run larger credit card balances to finance more expensive gas, that means fewer loanable funds are available somewhere else, reducing expenditures there. Banks (other than central banks) cannot create resources out of thin air. If I run larger balances, someone else somewhere isn't getting credit. Of course the central bank could start creating more credit, but then we really *would* have inflation!
