Global Econ on Quora: Recent Inflation Topics
I’ve started answering questions on Quora a few times a week. Here’s my profile: https://www.quora.com/profile/Global-Econ-Chris
Several people now ask them of me directly. Here are some of the latest on inflation related topics and I thought they might interest some of you.
My answers are unedited and I only answer where I can write a quick reply that hopefully helps provide insights. Below are the dates I wrote the Quora answer. I show the question (Q) and my answer (A).
Enjoy and thanks for reading!
September 19, 2022
Q: What is the Federal Reserve's inflation target?
A: The Federal Reserve’s inflation target is 2%. Period.
They posted this on their website and maintain that target today. Now, if pushed, they’ll say that this is the target for “core inflation” that excludes food and energy prices. Today core inflation is around 6%, so THREE TIMES the Fed’s target.
The target is a long-run target and they aim to hit it “on average” over time. That means at any point in time actual inflation might be a little higher or a little lower, but should fluctuate around 2%. Normal fluctuations might see inflation at 2.5% or 3% or down to 1.5% or 1%. Once it gets too far away though, the Fed is clearly failing to hit its inflation target. They might let that happen if unemployment is too high. Other times, like now, it’s happening because the Fed has failed to contain inflation.
Finally, the US Fed officially has what is called a “dual mandate”. Mandate 1 is to keep inflation near target. Mandate 2 is to keep unemployment at what we believe is the natural rate of unemployment in the US. Probably the Fed would argue the natural rate is around 4%. So, today, inflation is WAAAAAY above target and unemployment is way below target. The Fed is failing at it’s job. Currently it’s trying to get back on track and not loose too much credibility doing so.
September 19, 2022
Q: Why does Powell tell Jackson Hole Fed's 'overarching focus' is reducing inflation?
A: Powell knows that the key to real success for the FED is to anchor long-run inflation expectations. If markets believe he and the Fed are committed to getting inflation eventually back to 2% and keeping it there, then it actually makes the Fed’s job easier.
The reason is that private market participants won’t build higher inflation expectations into new contracts. Or, they will, but maybe they include 4% into contracts coming due next year because they believe he’ll succeed and get inflation down to 4% by middle of next year.
We all want that because it means inflation will come down faster and with less of a rate hike (i.e., less of a push) from the Fed. Rate hikes are painful. So the lower we can get inflation without hiking interest rates, the better - and the less painful - for everyone.
To see this, consider the opposite: If people do not believe the Fed is focused on reducing inflation, then they expect higher inflation next year, say 8% again. They start putting that in contracts today! Now, there’s nothing the Fed can do to lower those contract prices but they will feed into inflation over the year and keep the inflation rate at 8%. To get inflation below 8% the Fed will have to raise interest rates much, much more to get all other (non-contracted) prices down even more to offset the 8% in the contract-fixed prices. That’s more pain for everyone.
September 9, 2022
Q: Does anyone benefit financially from inflation?
A: Surprise inflation, definitely. Expected inflation, not as much…but (caveat at the end).
Borrowers benefit from unexpected inflation in general. If I borrow $100 from you when we both expect zero inflation, then next year I pay you back $100 (ignoring any interest you might have charged me). But if inflation turns out to be 10%, then next year, I still pay you $100, but those 100 dollar bills are only worth $90 due to inflation. So I gained and you lost. This holds true across the economy. Banks hate surprise inflation, for example. If inflation is anticipated, then we include it in our calculations. I borrow $100 from you and we both agree I repay you $110 next year to account for the inflation we expect (plus I’ll pay you more for interest).
BUT… caveat. The government usually financially benefits from inflation. The reason is that the government can print money to pay for something today (like we did during Covid in 2020 and 2021), but not have to raise taxes or borrow anything. Then when inflation comes around around, business revenue looks higher (due to inflation) so sales tax revenue to state and local governments goes up. As salaries rise due to inflation, the income taxes we have to pay goes up. AND… the government also borrowed tons of money in the past, so it’s a borrower and benefits from the surprise inflation like in the example I gave above. So, governments always actually like a little inflation and a little surprise inflation is even better. Now and then, mind you. When it gets out of control, voters get upset and elected politicians don’t like that.
Finally, as a general rule, inflation is truly brutal on the people with the lowest incomes in our society. They can’t avoid it. A rich person - even a middle income person like me - will feel it, but I don’t miss meals because of it. A poorer person - as many of us have been at times in our lives - has to choose between filling up the gas tank to get to work and eating lunch. And a person stuck with a low income really struggles to buy food and pay the bills at home to keep the lights even on. So, inflation is really one of the most brutal and regressive forms of “taxation” and it is truly hard on those least able to handle it.
September 9, 2022
Q: Why is inflation a never ending process?
A: Fundamentally, once we invented money and then handed over to governments to manage our national currencies, inflation management will always be a matter policy makers must deal with.
Without national money, people earn from supplying and that generates their income which they then use to buy goods. So supply and demand are intimately linked and will balance out on average over time. Demand can’t rise faster than supply for a long period of time because the money financing demand is literally coming from supplying goods and services.
Once a national currency exists, the question of how much money should be printed must be dealt with. Ideally the government prints it at about the rate that supply is growing and that keeps everything in line. People still earn what they supply and the currency they use is available at about the rate they need it.
If the government prints too much, then people FEEL like they have more money and try to spend it but fundamentally it’s not generated by producing goods and services so it’s “too much money chasing too few goods”. That’s inflation.
The opposite can also happen and during the Great Depression the US Fed made the opposite mistake, letting money actually contract and that caused deflationary problems.
So, it’s always up to the government to keep it balanced.
Finally, it was hard enough to keep it balanced when it was physical pieces of paper (cash). Today it’s credit and digital records in computers and much harder to control precisely. The Fed knows that and has erred on the side of caution, keeping inflation low for many years. But recently they let it get out of control during Covid, not realizing (I think) they had way over generated the amount of modern money (credit) that the economy needed and are having a hard time getting it back under control. But this is why they set an inflation target and try to meet it on average over time. By the way, they haven’t hit their target in years…. it’s a never ending process.
Hope that helps.
September 9, 2022
Q: Why does the Federal Reserve keep underestimating inflation?
A: This is a tough one and a bit of a mystery to me. I wrote about it a few times online (links below).
I would say there are two broad reasons. Broad reason 1: At any point in time, it’s hard to see if higher prices are permanent or temporary (“transitory” as they called it last summer). That’s always true. The Europeans are just dealing with their inflation now. So the Fed - which was slow and late in my opinion - was actually quicker to take inflation seriously than many other countries. But, Broad Reason 2, we have completely changes how money flows and banking work in the United States since the Great Financial Crisis (2008) and I do not think we - meaning academic economists and monetary policymakers - understand anymore what fundamentally determines inflation. There’s a huge debate and no one seems totally right. Either it’s too much money chasing too few goods - and we did way over print money in 2020 and 2021 - but if that’s it, then it’ll go away on its own. Or it’s too low interest rates for too long and indeed we kept them near zero for a long time (but Europe did too and worse and their inflation is picking up now, probably more due to energy prices and the war in Ukraine). Or it’s fundamentally concerns around the sustainability of our government’s finances. So our debt and expected future deficits are causing it. But while the US is at 100% debt to GDP, Japan is over 200% and has lower inflation.
Untangling these is tough. And I think they Fed is overestimating its ability to control inflation. I think they think they can print what they want, the raise interest rates and manage to keep inflation in check. So it’s not as much underestimating inflation as it is overestimating their abilities. So they waited too long thinking that when the time comes, they could just get it under control. But I think they are wrong.
September 9, 2022
Q: Did you know that the Inflation reduction Act does nothing about inflation?
A: Yep. At BEST it does nothing. More likely it will make inflation marginally worse. Sad really.
September 8, 2022
Q: What are the factors that affect the management of inflation in an economy?
A: Short answer: When the government prints too much money relative to GDP, it generally leads to inflation. This can happen by printing money or by lowering interest rates a lot, making credit super cheap (and credit today is essentially money). Either way, the government is allowing everyone to spend beyond their means, so to say, and that drives up all prices in general.
This is why managing inflation is the responsibility of a government agency, the US Fed (and Congress). This is why the Fed is raising interest rates to make credit more expensive, hence decreasing its abundance and thereby hopefully slowing inflation. It’ll be complicated by things like low supplies of some goods, global energy shortages and other things that temporarily drive up prices.
Longer answer: Think of an economy as a closed system first. People work to produce things that other people will want. From that, people earn income which they use to buy products from other people. When you are buying things, you are on the demand side of the market. When you are producing things (at work, usually) you are on the supply side of the market. And you make money from supplying that you then use in demanding.
As a general rule then, supply and demand tend to sort of balance out. You can only increase your demand by supplying more (and thereby earning more) and others do the same.
When demand rises faster than supply, prices rise because goods become scarce. The only way for this really to happen long-term in aggregate is for an outside force to add “income” or “wealth” to people’s pockets that comes from somewhere other than supplying goods to other people.
The only sources of external funds is the government. That’s why, in the end, the buck stops with them (pun intended) when it comes to inflation.
Note, in an open system where we trade with the rest of the world, external sources of funds could come from abroad. The difference is that we would trade for those funds (i.e., invest them and pay returns, borrow them and repay them or something). That “external” source would only be inflationary if a foreign entity dumped US Dollars (that they already have) into the US economy, buying up goods and services. But that doesn’t generally happen although it is one feasible possibility.