The One Number That Proves the Inflation Threat Is a Bogeyman

We have a situation where we have significant inflation in some sectors of the economy, but we also have enough deflation to offset it. I'm not talking about bad deflation, I'm talking about new advances in microchips, etc., that make computers cheaper and more powerful every year.

Inflation and deflation are natural aspects of a dynamic economy. The thing to watch for is when they signal structural problems. If microchips increased in performance so quickly that vendors refused to order inventory and store shelves were empty, then it would be a structural concern. Policymakers find it useful to wave the very imprecise notion "deflation" in front of the public without bothering to mention that it's all due to technological advancement, automation, outsourcing, etc.

Similarly, inflation isn't always bad -- developer salaries are "inflating" now, which sends a signal for more people to learn to write code. This will be self-correcting. The thing to be concerned about is when government action causes inflation sufficient to undermine peoples' willingness to accept the currency.

Policymakers try to get away with doing as much micro-tweaking as they can with the economy. Tax breaks for one select group of people, subsidies for another, etc. These sorts of policies can, over time, create inflation that is not self-correcting, since the policies are rarely ended once they have been created. Consider the massive over-investment in real-estate fueled by tax breaks. This led to an unstable real-estate market that crashed hard a few years ago.

"Let's try a thought experiment. If inflation really is 10 percent, that implies that real GDP fell around 6 percent last year. How bad is that? That's roughly where the economy was in the first quarter of 2009. Basically, complete free-fall. And thanks to Okun's Law -- which relates real GDP and unemployment -- we can guesstimate what that would mean for jobs. A back-of-the-envelope estimate says that unemployment should have risen between 3 and 4 percent in that scenario. Instead, we added 1.899 million jobs in the last year."

But of course jobs and production (GDP) do not need to grow in lockstep. This assumes that productivity is constant. If productivity is falling, then production could be declining even as the number of jobs increases.

For example, if the star employee (say Steve Jobs) of your company (Apple) no longer works there, your company may still suffer a production loss even if several employees are hired to replace the star. This is a case where production can fall even as employment increases.

However, in the long run there is little doubt that an expansion of the money supply will cause a rise in the price of goods and services.

Forget fancy metrics like NGDP and consider this thought experiment: if all of a sudden magically everyone's bank account balance had the decimal point moved to the right one place, what would happen to prices? After a very short transient period, they would increase by about a factor of 10. This is exactly what is happening right now (on a smaller scale and the magic occurs in the treasury department). The difference is that the extra money has been created, but is not really in circulation. Once banks and companies feel they no longer need the money in their accounts and can begin to put it into the general economy, prices will rise. Sure, the fed could take action to take money out of circulation as companies release it into circulation, but that is too politically unpopular and won't happen.

Head squid Goldman just slashed their April NFP employment estimates to 125,000, just barely higher than the disastrous March 120,000 NFP print which launched a thousand new QE rumors.

What is the point of this article? Is it to get everyone to nod their heads while they prepare to launch another round of QE? The NFP numbers prove that unemployment is not really doing that great.

I think this article is short-sighted. The prices of things like gas matter because the cost of energy impacts everything. The central planners' only tool is injection of more liquidity, which has a direct impact on the cost of commodities, oil, etc.

We've already been pumping the market with liquidity. Where did it all go? To euro banks, it seems. The employment numbers are not reflecting it, that much we know. Is this article suggesting we keep course?

> The things people buy the most often -- gas and groceries -- have gone up the most the past few years. The things people buy the least often -- gadgets and other goods -- have not. It's an understandable mistake. But still a mistake.

Can someone explain the math behind this? The important thing is not "how often", but "what percentage of the overall expense", but I would guess that (as percentage of overall expense), gas and groceries are larger than gadgets for everyone?

As an example, in my household, we're about a thousand/month on food & transportation (rising much faster than 2%/year), thousands a month for rent (rising much faster than 2%/year). And while gadgets are getting cheaper (nothing else seems to), they account for ... say, 2% of our overall expenses.

I have no idea whether "rising price inflation" has been underreported, especially by design, by the government. I would concede that there are political and bottom line reasons (e.g, minimize increases in salaries/benefits tied to COLA), but again, if this is happening, IMO it is probably more just institutional slouch than a top-secret directive from the Federal Reserve bunker.

Overall, I don't have an informed opinion what the facts of the matter are wrt to underreported inflation - I only have anecdotal evidence.

OTOH, it is pretty clear that "money supply inflation" has increased dramatically in the past few years due to the various policies associated with the bailout.

Whether this will cause "rising price inflation" remains to be seen - there is always latency between money supply increase and rising prices. In the bailout policies case, the latency is pretty large, as the bulk of the money went to securing "toxic" assets and so forth rather than directly into the consumer economy.

The overhang of this increase in money supply/government debt naturally constitutes rising price pressure, but again, how much is anyone's guess, as there are deflationary pressures as well (falling asset prices, and such).