Inflation VII

 

I Can’t Make You Love Me

'Cause I can't make you love me if you don't
You can't make your heart feel something it won't
Here in the dark, in these final hours
I will lay down my heart and I'll feel the power
But you won't, no you won't
'Cause I can't make you love me, if you don't

Trying to make demand when there is no demand is just as bad.

I have argued in previous blog posts that inflation has two parts, long-term currency inflation. https://dbeagan.blogspot.com/2018/08/the-happening-riding-high-on-top-of.html and short-term product inflation  https://dbeagan.blogspot.com/2022/02/inflation-predictions.html.

In the most recent episode of the Planet Money podcast they discussed the 2% inflation target. https://www.npr.org/2023/01/13/1149071772/two-percent-target-inflation-expectations. It was argued that an inflation of 2% was tolerable because if someone takes 2% of your beer you won’t notice. But if someone continually takes 2% of your beer, you might not notice on each sip, but eventually you will have no beer. To prevent this a zero percent inflation target sounds like even more of a more reasonable target.

Zero percent was discussed and dismissed because the US central bank, the Federal Reserve, can’t lower its interest rate below zero when inflation goes below zero, i.e. deflation. I would argue that this confuses the role of the Fed. It’s role to serve as the lender of last resort, to provide liquidity to smaller local banks and provide for the nation's currency. It has done this, has prevented runs on banks, and successfully transitioned the US to a fiat currency where the fiat is constrained by the US economy. However since the dollar is also used in international trade, the constraint should arguably be the international economy, not just the US economy. That it is only constrained by the US economy means that  there is more demand than there are US dollars, and currency inflation has been the result.

Product inflation has much more to do with product supply and demand. If the interest rate goes up, then the cost of producing goods goes up. and supply is reduced. If the interest rate goes up, then there is a time shifting of demand from tomorrow to today. Since price is when marginal cost is equal to marginal demand, changing supply and demand can affect prices. However as noted, you can time shift demand, but you can’t create demand.

The goal of currency inflation should be zero. There should be no goal for product inflation and just an acceptance of whatever supply and demand  randomly dictates for product prices. Supply can be contracted by increasing interest rates. Demand can be shifted in time but not created. Maybe setting interest rates below zero to increase supply is impossible ( but isn't that what tax credits and other subsidies do?). The hubris of thinking that we can control short-term product inflation has led the Fed to think that it can control total inflation. As long as long-term currency inflation is zero, even if short-term product inflation is sometimes greater than zero and sometimes less than zero, that should be expected and tolerated.