Inflation is a period during which price indices increase. But price indices can increase for all sorts of reasons; hence it makes absolutely no sense to study the impact of “inflation” on any other variable. That impact will always depend on what causes the inflation.
David Beckworth recently directed me to a speech by Lael Brainard:
While national data do not directly disaggregate the differential effects of inflation by household income groups, a variety of evidence suggests that lower-income households disproportionately feel the burden of high inflation. Lower-income families expend a greater share of their income on necessities; have smaller financial cushions; and may have less ability to switch to lower-priced alternatives. Arthur Burns noted in the late 1960s that “there can be little doubt that poor people…are the chief sufferers of inflation.”
Today, inflation is very high, particularly for food and gasoline. All Americans are confronting higher prices, but the burden is particularly great for households with more limited resources. That is why getting inflation down is our most important task, while sustaining a recovery that includes everyone. This is vital to sustaining the purchasing power of American families.
Brainard is right that we need to get inflation down, but the rest of the analysis makes little sense.
Here it might be helpful to distinguish between two broad types of inflation, stagflation and boomflation. Stagflation occurs when the short run aggregate supply curve shifts to the left. This reduces real output and real income, while boosting the price level. Boomflation occurs when aggregate demand shifts to the right, boosting real output and real income (in the short run), while increasing inflation. The late 1960s were an example of boomflation while 1974 was an example of stagflation. (Today we have some of each.)
In the late 1960s, Arthur Burns suggested, “there can be little doubt that poor people…are the chief sufferers of inflation.” Actually, boomflation raises real income in the short run, including the real income of the poor. Indeed the 1960s saw one of the largest reduction in poverty rates in all of US history. The inflation of the late 1960s was bad, and should have been prevented by tighter Fed policy. But it wasn’t bad because it hurt the poor (in the late 1960s); it was bad because it led to greatly increased economic instability during the 1970s.
In contrast, stagflation does hurt the living standards of the poor. But the reduction in living standards is caused by the “stagnation” part of stagflation, not the “inflation” part of stagflation. Given the existence of an adverse supply shock, a non-accommodative Fed policy that prevented any temporary increase in the overall inflation rate would hurt the poor by even more than did the stagflation. I would add that stagflation hurts both the poor and the rich, whereas boomflation helps both the poor and the rich in the short run, and hurts both the poor and the rich in the long run. Income inequality is not the issue here.
Whenever you encounter any study of “the impact of inflation”, run for the hills. It’s likely to be complete nonsense, an exercise in reasoning from a price change. It would be as silly as a study evaluating the impact of high oil prices, without first ascertaining whether the price increase was caused by more oil demand or less oil supply. In the former case, oil consumption will rise. In the latter case, oil consumption will fall. Or a study looking at the impact of higher interest rates, without first considering why interest rates had risen. Tight money? Higher inflation? A booming economy?
PS. Notice that I had to invent a word to do this post? (Boomflation.) Also notice that the economic profession has no word for “NGDP growth rates”. When a science lacks words for some of the most important concepts in their field, it’s a pretty good indication that the subject is hopelessly confused.
PPS. Shorter version of this post: NRFPC
READER COMMENTS
Market Fiscalist
Jul 13 2022 at 10:32pm
The difference between boomflation and stagflation as you describe them seems to simply be that for one RGDP is falling while for the other it is rising. In both cases NGDP must be changing at a faster rate than RGDP in order to get the “flation” bit.
Obviously people get better off when RGDP is rising and worse off when its falling no mater what the inflation rate is – so I’m a bit confused what point is being made here. Is it that initially inflation will cause the aggregate supply curve to shift to the left, but eventually (f the inflation persists) it will shift to the right or something else I am missing ?
Market Fiscalist
Jul 13 2022 at 11:37pm
BTW: I can see why persistent inflation may cause the AS curve to shift to the left (and lead to stagflation) but not why “initial” inflation would cause an AS shift to the right (rather than along the curve).
Scott Sumner
Jul 14 2022 at 12:20pm
I never said anything about AS shifting to the right. And inflation doesn’t cause AS to shift, you’ve reversed causality.
My point is that it makes no sense to talk about the effects of inflation in general. What kind of inflation?
Market Fiscalist
Jul 14 2022 at 3:59pm
Apologies, I totally misread the post!
Market Fiscalist
Jul 15 2022 at 10:17am
However on ‘And inflation doesn’t cause AS to shift’: Couldn’t persistent but unpredictable inflation cause disruption to the economic system (business planning, etc) such that the AS curve might shift leftwards ?
Scott Sumner
Jul 15 2022 at 11:57am
Yes, but that’s not a direct effect of inflation on AS. It’s a more of a long run effect.
vince
Jul 13 2022 at 11:40pm
Isn’t the cause of inflation always and everywhere a monetary phenomenon?
Roger Sparks
Jul 14 2022 at 9:14am
And isn’t “monetary phenomenon” found in two flavors: money-supply increase and velocity-of-money increase?
Scott Sumner
Jul 14 2022 at 12:22pm
“Isn’t the cause of inflation always and everywhere a monetary phenomenon?”
No. Inflation does not require any increase in either the money supply or velocity.
vince
Jul 14 2022 at 12:50pm
Yet it is still a monetary phenomenon.
Scott Sumner
Jul 14 2022 at 2:35pm
You said the “cause” of inflation is monetary. That’s different. Yes, the definition of inflation is a fall in the value of money.
vince
Jul 14 2022 at 4:30pm
Different, in a nitpicky kind of way.
Jack Tatom
Jul 14 2022 at 9:57pm
Inflation is not a fall in the value of money. It is a persistent or continuing decline in the value of money, in the absence of a change in economic policy or ongoing changes in the factors determining the value of money. This is largely due to an increase in the rate of growth of the money supply with no change in the output or its underlying growth rate of capacity.
A change in capacity output can also change the demand for money and the price level. Over the period in which the economy adjusts to the loss in capacity output, prices will temporarily accelerate giving rise to an appearance of higher inflation. Once the economy adjusts to the change in supply conditions, inflation will return to its underlying rate. So a price level shock can appear to be a transitory surge in inflation. A corollary is that a permanent change in the growth of output due to a continuous ongoing change in supply conditions could lead to a sustained change in the rate of price increase, but such things are curiosities that have never been observed. Crop failures in agrarian societies or energy price shocks reduce the level of output and temporarily raise the rate of price level changes as the economy adjusts to the higher level of the relative price of a resource or to a one time loss in technology, more likely caused by a regulatory change outlawing and existing or new technology.
so the old fashioned notion of a permanent rise in the rate of deterioration in the purchasing power of money only arises from a permanent increase in the rate of growth of the money supply.
As in the 70s, and 80s, is both. The energy price shock reduces energy use, and vice versa, tacking on a little extra temporary inflation, but the larger long term problem is that two years of record historical monetary expansion, no letter how one measures it, will continue until the Fed returns to a Taylor rule type regime where policy aims to influence interest rates to rise by much more than observed inflation increases.
The temporary strength of labor markets reflects the productivity losses arising from a one-time rise in real energy prices, where employment growth has been temporarily boosted by labor demand to make up for some of the output decline. Most of that is typical stagnation where prices rise and output fall. The focus should be on the underlying loss in productivity, real wages, investment and economic growth. All more apparent than the inflationary consequences of monetary growth. But the latter is more insidious than the short term effects of a supply shock. The Fed has not done much of anything so far to reduce the rate of growth of money, some 2-3 years after it was clear that the economy would be fine without any of the Fed’s overreaction in spring 2020, and it’s continuation.
and now we are worrying about the recession we are already in and disregarding the recession yet to come due to the Fed’s likely overreaction to past and continuing excesses of monetary growth. Reminds me of Gerald Ford’ convening of the WIN conference in August 1974 and rolling out of WIN, after a year of stagnation and the monetary contraction that was emerging. We quickly learned how to separate stagnation from a monetary induced recession of unseen recent proportions. Instead of “been there done that,” we have purported economists running around arguing about individual price changes instead of inflation and imagining it will all be gone by November, or nowadays by November 2024. Enjoy the earnings reporting season, the coming productivity reports and the modest unemployment surge that is coming.
Scott Sumner
Jul 15 2022 at 6:39pm
Vince, You said:
“Different, in a nitpicky kind of way.”
No, a definition and a causal claim are radically different statements. I think you are bit confused on this issue.
Jack, You said:
“Inflation is not a fall in the value of money”
Actually, it is. Inflation can be temporary of persistent.
Todd Ramsey
Jul 14 2022 at 10:13am
A possible Straussian interpretation of Brainard’s speech excerpt: Brainard has to justify continuing Fed tightening to give the Fed cover from attacks by the Biden administration, Elizabeth Warren, The Squad, and the political left.
Hopefully she wouldn’t quote Arthur Burns if she was truly speaking to economists!
vince
Jul 14 2022 at 11:14am
Yes, it sounds like a sales pitch.
Spencer Bradley Hall
Jul 14 2022 at 10:24am
In Friedman’s “The Counter-Revolution in Monetary Theory”
“Inflation is always a monetary phenomenon, in the sense that it can be produced only by money growth more rapid than output. ”
The “equation of exchange” P=M*V/T embodies the truisitc relationship between money flows and the aggregate value of all monetary transactions. P represents the unit prices of all transactions; T, the number of “units” of all transactions; M, the volume of means-of-payment money; V, the transactions rate of money flows; and M*Vt, the volume of money flows.
While the usefulness of the equations is somewhat diminished by the impossibility of quantifying P and T, the validity of the equation is not. Obviously, if the monetary authority allows the banking system to increase the money supply, ceteris paribus, (no change in V or T) prices will rise., etc.
Spencer Bradley Hall
Jul 14 2022 at 10:39am
If the monies represented by the debts (e.g., new money) are spent on projects which increase productivity & reduce waste, the debts are beneficial no matter how financed. The initial inflationary effects of bank financing are quickly overcome by the larger output & lower unit costs. Debt incurred which reduces unit costs of production & promotes the health & welfare of the population obviously is “good” debt.
Debt incurred to finance transfer payments (interest, pensions, etc.) is of dubious quality. Any enterprise, private or public, is in dire straits if it has borrowed in order to make such payments.
Iskander
Jul 14 2022 at 12:44pm
Its always a delight when I read a silly take about monetary policy and, as it often does, it turns out to be by a high ranking figure in a central bank.
Richard W Fulmer
Jul 14 2022 at 3:52pm
It seems to me that much of the confusion over inflation is that the definition of the word has changed over the years – shifting its meaning from cause to effect. The word “inflation” was first used in relation to money in the 19th Century. Then, I believe, it simply meant an increase in the money supply. Today, most people use the word to mean a general rise in prices (or, in Dr. Sumner’s post, a rise in price indices), which is a possible – though not the only – consequence of increased money supply.
As the quantity of money rises, prices of goods and services tend to be bid up, so inflation (in the word’s original meaning) tends to result in higher prices. However, prices do not rise uniformly because new money flows into some sectors of an economy before flowing into others, so there is no “general” price rise. For example, in the United States during the 1920s, the quantity of money increased by over 50% but the prices of most goods and services did not shoot up because productivity rose significantly during the same period, leaving the dollar-to-goods ratio nearly unchanged.
At the same time, however, real estate and stock prices rose significantly, but neither housing or stocks were (or are) included in the price index. Because the index was stable during the 1920s, Friedman was happy with the Fed’s inflationary policies. But those policies set the stage for the stock market crash when the Fed turned off the money spigot.
Complicating things is the fact that lower production and higher velocity can also drive prices up. Perhaps we need to coin even more words than those that Dr. Sumner has proposed to describe the following phenomena:
Increased money supply
Higher prices due to increased money supply
Higher prices due to reduced production
Higher prices due to higher velocity
Thoughts?
Scott Sumner
Jul 15 2022 at 12:17pm
I have a question. If you are chatting with a friend and say “I hear so and so is gay”, are you using “gay” in the sense of the 2020s or the 1890s?
It’s true that 100 years ago, “inflation” had multiple meanings (including money creation but also price rises), but now it means a rise in the price level. It is less confusing if we stick with that definition.
I would add that back in the 1920s, “money” usually meant the monetary base. Data on M1 and M2 was not even available. The Fed did not increase the monetary base during the 1920s. So if you want to use original definitions, the Fed did not have an inflationary monetary policy during the 1920s, even using the money supply definition. (Commercial bank deposits did rise, but those are not directly controlled by the Fed.)
Richard W Fulmer
Jul 15 2022 at 12:29pm
Fair enough on the terminology. Still, there are four different phenomena (monetary expansion, monetary inflation, production decline inflation, and velocity inflation) that are being discussed and debated. Labels would aid in the discussion and help avoid confusion.
If I recall correctly, Friedman and Schwartz (A Monetary History of the United States) found a 52-54% increase in the money supply during the 1920s. If so, where did the money come from if not the Fed or the Treasury? Thanks.
Scott Sumner
Jul 15 2022 at 6:31pm
Strong’s policies were not inflationary. Had they been continued during the 1930s we could have avoided the Great Depression. Instead, his polices were abandoned in 1929. That was a huge mistake.
“Still, there are four different phenomena (monetary expansion, monetary inflation, production decline inflation, and velocity inflation) that are being discussed and debated.”
That’s actually three. P might rise because M rises, because V rises, or because Y falls.
BTW, both M1 and M2 grew by less than 50% during the 1920s. Indeed, M1 hardly grew at all.
Richard W Fulmer
Jul 15 2022 at 7:03pm
Yet after his administration of medicinal whiskey in 1927, the DJIA more than doubled in only 18 months.
How much did M2 grow? Friedman and Schwartz put it at just over 50%. Richard Timberlake (Univ. of Georgia) says it grew by 46%. Where did that growth come from?
Richard W Fulmer
Jul 15 2022 at 12:54pm
The word “policy” might be too grand a label for New York Fed Chairman Benjamin Strong’s “coup de whiskey,” but his action was certainly inflationary.
Roger Sparks
Jul 15 2022 at 9:19am
I am picking up on your “hopelessly confused” observation. Please bear with me.
I am wondering if you, in the AD-AS Model, think of GDP on the X-axis? If so, stagflation and boomflation migrate as you write.
OTOH, if Y is on the X-axis, as in “Y = GDP/P”, then a stagflation event would move the AS line upwards. For example, an increase in the minimum wage should be a stagflation event. The AS line should move upward with no increase in output. Later, after the workers get paid, the AD line should also move upward.
Boomflation could be the result of a bank lending event wherein the money loaned came from existing money supplies. With Y on the X-axis, the AD line would move upward, meeting the requested price from suppliers. We would see a new GDP point established.
Both examples separate Y and P, and hopefully reduce confusion, but maybe it is only I who is confused.
Scott Sumner
Jul 15 2022 at 12:10pm
“Later, after the workers get paid, the AD line should also move upward.”
This is incorrect. An increase in the minimum wage does not boost AD.
Roger Sparks
Jul 15 2022 at 1:14pm
Agreed. An increase in the minimum wage does not boost AD. The AD curve does not reset until the next time GDP is measured, which is after the minimum wage employee has spent his increased wages.
Scott Sumner
Jul 15 2022 at 6:33pm
Wrong again. Increasing the minimum wage does not increase AD, even after the higher wages are spent. For AD to rise, you either need the money supply to rise or velocity to increase.
Richard W Fulmer
Jul 15 2022 at 7:17pm
I understand that you don’t want to call the expansion of the money supply “inflation,” but it’s still a real phenomenon deserving of a label. Whether it’s called “monetary expansion” or “George,” it exists.
Scott Sumner
Jul 18 2022 at 5:59pm
“I understand that you don’t want to call the expansion of the money supply “inflation,” ”
Yes, it’s true that I don’t want to use terms in confusing ways that would make it difficult to communicate with people. For the same reason, I don’t refer to happy outgoing people as “gay”.
Michael Rulle
Jul 16 2022 at 9:22am
What a field this subject “economics” is.
Maybe the lack of synonyms/definitions (for example) of “boomflation” simply come from the media and/or the government’s incomplete understanding.
I recall moving curves around in grad school——but I cannot be sure my lack of awareness, in this case of “boomflation”, was merely due to my lack of attention only, or because economists who taught also did not teach deeply enough. But it’s hard to believe they did not know it. But maybe they did not.
These seem basic to me once one learns it—-it’s not difficult. It definitely makes one wonder what other forms of language confusion is embedded in our journals and articles on countless subjects——Naturally I believe a lot—-not necessarily because I recognize it in real time——-but because eventually it is clear that a lot of what we read is false or misleading.
Mark Brady
Jul 16 2022 at 9:25pm
It is worth recalling that almost 160 years ago W. S. Jevons used the word “inflation” to refer to both monetary expansion and a rising price level in In A Serious Fall in the Value of Gold Ascertained, and Its Social Effects Set Forth (London, 1863).
“The inflation of credit must be checked by the well defined boundary of available capital.” (ch. 1, p. 13)
“A revulsion occasioned by a failure of the national capital must cause…a collapse of credit, and of any inflation of prices due to credit.” (ch. 1, p. 14)
“It is impossible to account for this permanent change [in prices] by any excessive speculation, inflation of currency, or credit.” (ch. i, 25)
Jim Glass
Jul 16 2022 at 10:17pm
Inflation? Let’s not forget the classic simple variation.
Sri Lanka collapses under exploding debt and rocketing prices…
Professor, I hope this isn’t too off topic, but I have a hard time getting over old times.
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