A slightly off-center perspective on monetary problems.
During the past several years I’ve repeatedly insisted that the huge increase in the monetary base of 2008 would not produce high inflation. I suppose I was naive in thinking that when it became clear that excessively low inflation was the real problem, the inflation hawks would admit they were wrong and re-evaluate their models. I don’t see much evidence of that happening.
One recent theme has been the supposedly unreliability of the core inflation rate, which is now below 1%. Critics (and cartoon bunnies) point to the fact that food and energy are an important part of the average American’s budget. When it’s noted that even headline inflation is barely over 1%, the attention turns to other prices. For instance, Congressman Ryan has recently argued that the Fed should focus on commodity prices. My initial reaction is to say “Yes! Let’s focus on commodity prices! Commodity prices are the best way to tell if money is too easy or too tight.” Think I’m being sarcastic? Then you are in for a surprise.
Before continuing, I’d like to remind readers that in late 2008 you could count on one hand the number of economists (in the entire world) claiming monetary policy was very tight. So let’s take a look at the change in commodity prices in late 2008:
That’s right, commodity price indices fell by more than 50%. That’s Great Depression-style deflation. And where was Congressman Ryan when the Fed was engineering one of the greatest deflations in world history? I don’t recall him or any of the other inflation hawks calling for easier money. But maybe I missed something. If so, I hope my readers will dig up all the stories of conservatives demanding easier money in the fall of 2008. In any case, it’s good to know that whereas back in late 2008 I was almost all alone in viewing money as being extremely tight, I now have the vast right wing conspiracy on my side. Money really was tight in late 2008. And if commodity prices are now the preferred metric of the right, then I’m half way to convincing the economics establishment that I was right all along. Now I just have to convince the left that money was way too tight in 2008. About those near-zero interest rates . . .
BTW, I don’t mean to bash Congressman Ryan, who is from my home state and is one of the best of a bad lot. If all 435 Congressmen and women were like him we’d probably end up with a much more economically sensible tax and spending regime. But I have to say that the conservative movement has recently been grasping for straws on monetary policy. All their predictions are coming in false, and they aren’t drawing the appropriate conclusions.
Update 12/19/10: This post wasn’t well written. I have always felt that commodity prices were one of many useful indicators of whether money is too tight or too easy. But I left the impression that I completely supported a monetary policy that single-mindedly focused on commodity prices. In fact, I’d prefer the Fed look at a wide range of indicators when estimating market NGDP growth expectations, including stock prices, bond prices, TIPS spreads, forex rates, commodity prices, real estate prices, etc. Many commenters correctly pointed out that commodity prices can be an unreliable indicator, and I entirely agree. I got overly enthused trying to show that if it was the right indicator, then money was ultra-tight in late 2008.
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22 Responses to “Disinflation denial”
Watching interest rates lately?
Scott wrote: “That's right, commodity price indices fell by more than 50%. That's Great Depression-style deflation. And where was Congressman [fill in the blank] when the Fed was engineering one of the greatest deflations in world history? I don't recall him or any of the other inflation hawks calling for easier money. But maybe I missed something.”
I’ve been pushing this theme a lot recently myself. But I’m honestly overcome with emotion right now. (It doesn’t take much.) Brilliant Scott!
You don’t have to apologize for bashing Ryan. I think at least half of your readers are neoliberal progressives. (And I feel like neoliberal progressive might be what you mean by “right-wing liberal”).
Hey Mark, how did the job market come out for you this year? I only know about literature fields, as I am an Adam Smith/eighteenth-century type of scholar. Anyone could put in a good word for me at Dartmouth or Furman? Or could I put in a word for anyone at UNM or Buffalo?
Shane, Your asking the wrong person about the job market. I’ve been pursuing the job market in the most inefficient manner possible. I don’t want to leave my beloved house at all. That leaves me with precious little choices. I’ll even settle for a position at Rowan University.
Professor Sumner,
Can you explain the logic of choosing commodity prices over the CPI or PPI? My assumption is that it most accurately expresses changes in “relative prices” as caused by changes in Ms and Md.
Joe
Shane, I’m sorry. That’s not entirely truthful. I may have not applied for positions further away but that’s not because I don’t believe I don’t qualify or that they wouldn’t consider me. It’s that I’m not willing to apply. I have a dandy Job Market Paper that I’m somewhat reluctant to unload.
The fact remains I’d rather live in my house. Mark
Muckdog: the answer to your question is yes he is.
Scott: As I understand it, deflation and disinflation both represent increases in the relative scarcity of money. Where they are unexpected, so not reflected in wage and price contracts, they have the same depressive effect on economic activity.
Scott, why didn’t you show us the graph starting at 94? (if I am right, yes, I noticed it is a reconstruction) http://www.jefferies.com/cositemgr.pl/html/ProductsServices/SalesTrading/Commodities/ReutersJefferiesCRB/IndexData/processChart.pl?Index=RJCRB_Total&StartMonth=01&StartDay=01&StartYear=1994&EndMonth=12&EndDay=17&EndYear=2010 So the low starting point was 63.9, is it not? Which means in 17 years to date it gives us almost 10% annual inflation. If we take the lowest point in 2009 of roughly 210 then we get a horrible incomprehensible and growth killing 8.2%. That is because if we take the max of 2006 (forgetting the “excesses of 08″) then we will end up with “normal” 12%+. And BTW, if we take 150-160 as an average for 2002 then we end up with the same 8% to date. So are YOU saying 12%+ is Ok and 8% is dangerously low?
Scott, the CRB index is up 60% since March 2009, now at 320.62, and higher than it was in August 2007. We also have to keep in mind the nearly 50% rise from August 2007 to June 2008 that preceded the drop you are concerned with.
By the CRB index argument, then, Fed policy was too loose in late 2007 and early 2008, too tight in late 2008 and early 2009, and too loose ever since. And we are having inflation now, and you are in “inflation denial.”
I don’t personally believe these things … but if you reject them, doesn’t that lead to questioning your thesis about late 2008?
Where in commodity prices does it explain why my grocery bills keep going up every month, while package sizes continue to decrease?
I can understand why Scott likes commodity prices: they have the advantage of being determined flexibly in highly liquid, highly efficient markets, so they react immediately to changes in expectations. But comments by Joseph and by Paul Jaminet point to the problem with commodity prices: namely, as I view it, that they’re determined in large part by “micro” factors, factors unrelated to inflation. In particular, most commodities are complementary with labor, so the increase in effective world labor supply over the past 25 years (without a corresponding increase in the effective supply of complementary commodities) has induced an increase in the real price of commodities. This might be regarded, though, as a low frequency change and contrasted with the high frequency change depicted in the chart. The market didn’t suddenly realize in late 2008 that the increase in world labor supply was coming to an end (nor was there a sudden discovery of new commodity supply), so the rapid decline was clearly attributable to a fall in aggregate demand. It’s also hard to argue that the rally in early 2008 was caused by an expectation of rapidly rising aggregate demand. After all, we were in a recession. (As I recall, Brad DeLong called the business cycle peak within a month, and he was certainly not the only one who realized that aggregate demand was weak.) More likely it was a recognition that commodity supplies were tighter than previously realized (both in absolute terms and relative to the labor complement). All in all, I’m inclined to conclude that Scott is right: the fact that commodity prices remain far below their 2008 peak is evidence of disinflation.
Scott,
How can crashing commodity prices signal the Fed is too tight, but spiking commodity prices not signal the Fed is too loose?
Q1: If the Fed had stepped in with an NGDP level target just before Lehman’s failure, what would headline inflation have been in 2009/2010? Would the Fed then have been forced to tighten in 2009? Remember, absent a fall, 2008 NGDP crash, a “level” target would not have a large gap to make up, thus forcing the Fed to tighten sooner.
Q2: If real China growth explained the early 2008 commodity price spike, then how did the August, 2008 Fed meeting signal to traders that they should dump commodities despite Chinese growth? At this meeting, the Fed left the FFR unchanged.
Scott, you wrote: Before continuing, I'd like to remind readers that in late 2008 you could count on one hand the number of economists (in the entire world) claiming monetary policy was very tight.
Interesting, Here’s my post from Oct 10, 2008 titled <a href="http://ontrackeconomics.blogspot.com/2008/10/2008-federal-reserve-tightening.html"The 2008 Federal Reserve Tightening.
By the way, the point I was making in that post was that while they’d been tight, they had very recently engineered a massive easing: Finally, an Easing of Policy, and What an Easing!
Now look at the current Federal Reserve H.6 report. Note that Demand Deposits, seasonally adjusted, have exploded in September, reaching just over $400bn in the September 29th week, an increase over trend of more than $100bn!
It’s not a String the Fed is Pushing On; It’s an Iron Bar
Again, you need to read the monograph to understand this. In any case, if you go to this link to the Federal Reserve’s current H.3 Release and look at the Excess Reserves column in Table 1, you will see that after running just below $2bn for the entire year, excess reserves have now exploded to nearly $70bn in late September and to $136Bn in early October! This is exactly what has caused the huge increase in demand deposits.
If ever there was an economic environment where the “pushing on a string” theory would seem applicable, this would certainly be it. Yet demand deposit growth, i.e., money supply growth, has ballooned at a rate never before seen (though we came close at the turn of the century and also after the 9/11 terrorist attack.) It’s not a string, it’s more of an iron bar.
That post concluded with my comment (referring to the impending payment of interest on excess reserves) “Next, I’ll discuss how our inept government is on the verge of converting the extremely useful “iron bar” to that limp “string” everyone is always talking about. Really. That’s what’s in the works, and it’s important that we understand the implications.”
Oh, and in the post dated December 2, 2008 I forecast that based on that huge money burst referenced above, the turn in the economy would come begin in March of 2009. Note that the April-June quarter was, in fact, the first quarter to experience positive real growth.
I also noted in my last post on that blog, on March 13, 2009, that the economy was starting to turn upwards at that time. I included the following comment:
Interestingly enough, a poll at CNN on when the economy would recover offered no option for “soon” or “now” and only 22% of respondents even chose the “later this year” option. The other 78% are looking for the recession to last until the end of this year at least.
My point in posting all this isn’t to crow. It’s to illustrate that the way I understand the Fed to operate (in the past until very recently at least) does make sense and that if the Fed actually would read my monograph and apply it they would have all the control over the price level that they would need. They could also stop causing boom/bust recessions on a regular basis as they’ve done since the early 1950’s. Unfortunately, that doesn’t seem likely to ever happen.
P.S. Too much html in this one…hope it posts correctly Scott. If it doesn’t, I’ll redo it.
Well, the link didn’t take. I’ll try again.
The 2008 Federal Reserve Tightening
Muckdog, Yes, they’re going higher (which is good) but they need to go higher still.
Thanks Mark and Shane, and good luck on jobs.
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