Is the way central banks view inflation simply wrong?

[achilles28]

Quote from morganist:

This will be a good debate.

http://morganisteconomics.blogspot.co.uk/2012/10/is-way-central-banks-view-inflation.html

Thanks for your contributions, Peter.

I think Monetarists lose sight that inflation is actually a relative definition (between two variables), rather than strictly a money supply phenomenon.

The price level (inflation or deflation) is best defined by the ratio of goods and services available to money supply.

If gross domestic output held constant, money supply up = inflation.
If gross domestic output held constant, money supply down = deflation.

Where it gets interesting, perhaps:

gross domestic output up, money supply held constant = deflation
gross domestic output down, money supply held constant = inflation

In either case, it's the ratio of money available to goods and services available that determines inflation/and how much.

Right now, if you examine total credit market debt (true total money supply), we're at ~08 highs (~60 trillion?). However, gross domestic output is way down. Lots of money chasing fewer goods = stock market and commodity inflation.

This is similar to your postulate that with increasing money supply (relative to goods produced) comes a devalued currency, which is a more accurate definition of stock/commodity/asset inflation. Hard assets aren't appreciating, per se. The value of the dollar used to price them, is falling.

Anyway, I agree with swannoir. It's all bs. The guv uses a concocted inflation definition to assuage the market and keep the gravy train running. Why, if they were to report inflation using the 80's CPI, it'd be well over 7%, and then they'd have to act (raise rates), by their own admission! This way, they can lie to the public, to keep the music going. Nobody in Washington (or the FED) wants to be kicked out next election cycle!!! It's all corrupt shit, excuse my language.

 

[Arnie]

I did not see this brought up, but could part of the problem with how the Fed views/reports inflation have to do with the dual mandate? How do you really fight inflation if that means higher umemployment? I think if this 2nd mandate were removed, you would hear a different tune from Ben & Co.

 

[morganist]

Quote from achilles28:

Thanks for your contributions, Peter.

I think Monetarists lose sight that inflation is actually a relative definition (between two variables), rather than strictly a money supply phenomenon.

The price level (inflation or deflation) is best defined by the ratio of goods and services available to money supply.

If gross domestic output held constant, money supply up = inflation.
If gross domestic output held constant, money supply down = deflation.

Where it gets interesting, perhaps:

gross domestic output up, money supply held constant = deflation
gross domestic output down, money supply held constant = inflation

In either case, it's the ratio of money available to goods and services available that determines inflation/and how much.

Yes but when the majority of goods are produced outside the domestic economy does the price at which you are able to purchase them become the determining factor in regards to inflation?

 

[achilles28]

My bad. Stardust already brought it up.

 

[achilles28]

Quote from morganist:

Yes but when the majority of goods are produced outside the domestic economy does the price at which you are able to purchase them become the determining factor in regards to inflation?

Yes, but it's one in the same. Increase money supply to output = declining currency value, which is inflationary. It also equates to more money chasing fewer goods within the domestic economy.

Currency values are just relative measures of purchasing power, which is another metric of inflation/deflation. Higher purchasing power = deflationary. Lower purchasing power = inflationary. It's all the same thing, using different terms. That's why economies undergoing contraction experience currency strength, and economies undergoing expansion/boom experience currency weakness. In the former economy, money supply relative to goods is dropping, each unit of currency has more value = currency appreciation. Same in reverse.

As far as the traditional metric of inflation - the CPI (defined consumer product basket) - currency value is factored in by the cost of imports included in the basket (electronics, clothing, food etc).

 

[morganist]

Quote from achilles28:

Yes, but it's one in the same. Increase money supply to output = declining currency value, which is inflationary. It also equates to more money chasing fewer goods within the domestic economy.

Currency values are just relative measures of purchasing power, which is another metric of inflation/deflation. Higher purchasing power = deflationary. Lower purchasing power = inflationary. It's all the same thing, using different terms. That's why economies undergoing contraction experience currency strength, and economies undergoing expansion/boom experience currency weakness. In the former economy, money supply relative to goods is dropping, each unit of currency has more value = currency appreciation. Same in reverse.

As far as the traditional metric of inflation - the CPI (defined consumer product basket) - currency value is factored in by the cost of imports included in the basket (electronics, clothing, food etc).

I still think that the nature of interest rate changes and QE are different in relation to inflation. I think the issue is the size of the situation. The interest rate will impact on the domestic economy not the global one. However QE will have a dramatic effect on currency value which interest rates will not because it is currency debasement. Low interest rates are not debasement money is not created credit is expanded. The impact of QE will be more dramatic on currency change than low interest rates because it means the money supply has actually depreciated in value in real terms. Whereas an interest rate reduction does not debase the currency. It may have an impact on currency prices on the open markets but it not have the inherent inflationary effect debasement will have. This will deter investors due to the real term loss they will make reducing currency value further than an interest rate reduction would.

When credit is expanded the expected outcome is it will be paid back. When debasement occurs it is an expected loss.

 

[achilles28]

Quote from morganist:


When credit is expanded the expected outcome is it will be paid back. When debasement occurs it is an expected loss.

I think you're both right and wrong. Both credit expansion and QE exhibit a debasing effect on the currency. Check any currency against commodities during periods of economic expansion. They depreciate nicely. As for QE versus credit expansion, yes, QE depreciates the currency 'stronger' than credit creation.

 

[morganist]

Quote from achilles28:

I think you're both right and wrong. Both credit expansion and QE exhibit a debasing effect on the currency. Check any currency against commodities during periods of economic expansion. They depreciate nicely. As for QE versus credit expansion, yes, QE depreciates the currency 'stronger' than credit creation.

No you are right I didn't explain it very well. Well noticed. I have ammended the last three paragraphs below to express what I meant to say. Thanks for pointing that out.

"This is the worrying prospect, the assumption that inflation is related to domestic money supply and domestic output presumes the outcome of Quantitative Easing would be to push the money supply up against domestic output to the level needed to hit inflationary targets. When in fact, if the true impact domestic money supply alterations have is the effect on currency value and the ability to purchase foreign goods, all that Quantitative Easing will do is depreciate the purchasing power of the currency creating inflation through debasement.

Perhaps another way to look at the situation is the view of deflation. The assumption is it is a result of a lack of money supply in the domestic economy, which may be true to a certain extent. However if the money is pumped into the economy through Quantitative Easing the ability to purchase foreign goods will diminish as a result of currency devaluation, this will in turn likely create inflation as a result of debasement. When interest rates are lowered credit is expanded and the expected outcome is for the debt to be paid back.

When debasement occurs it is an expected loss. Quantitative Easing will have a more dramatic impact on the currency value than a reduction in the interest rate because it is a real term loss not an increase in the domestic money supply of one nation through credit expansion. Therefore it is possible to state that the current view of inflation and its causes has really been an observation of another macroeconomic relationship, which has created confusion about the nature of domestic money supply and how it should be applied in certain situations. It does not necessarily hold true that all alterations in money supply will have the same impact on prices if another tool is used to influence it."

Is that better?

When money supply is increased through interest rates the currency value is changed by the volume of money supply and the imapct it has on exchange rates. When money supply is increased throguh QE the integrity of the currency itself is questioned decreasing value.

 

[achilles28]

Quote from morganist:

No you are right I didn't explain it very well. Well noticed. I have ammended the last three paragraphs below to express what I meant to say. Thanks for pointing that out.

"This is the worrying prospect, the assumption that inflation is related to domestic money supply and domestic output presumes the outcome of Quantitative Easing would be to push the money supply up against domestic output to the level needed to hit inflationary targets. When in fact, if the true impact domestic money supply alterations have is the effect on currency value and the ability to purchase foreign goods, all that Quantitative Easing will do is depreciate the purchasing power of the currency creating inflation through debasement.

Perhaps another way to look at the situation is the view of deflation. The assumption is it is a result of a lack of money supply in the domestic economy, which may be true to a certain extent. However if the money is pumped into the economy through Quantitative Easing the ability to purchase foreign goods will diminish as a result of currency devaluation, this will in turn likely create inflation as a result of debasement. When interest rates are lowered credit is expanded and the expected outcome is for the debt to be paid back.

When debasement occurs it is an expected loss. Quantitative Easing will have a more dramatic impact on the currency value than a reduction in the interest rate because it is a real term loss not a reduction (increase in debt? which is payed back at a later date?) in the domestic money supply of one nation through credit expansion. Therefore it is possible to state that the current view of inflation and its causes has really been an observation of another macroeconomic relationship, which has created confusion about the nature of domestic money supply and how it should be applied in certain situations. It does not necessarily hold true that all alterations in money supply will have the same impact on prices if another tool is used to influence it."

Is that better?

Yes, it's good. I think your formal education exceeds mine. But I have learned much of the formal stuff isn't all that practical, or relevant. I made one note above. Lowered rates encourage credit growth? Albeit, which is less destructive than outright monetization, because it's a debt instrument, with a maturity date, expected to be repaid, and therefore, destroyed. etc. ? Perhaps I read it wrong?

 

[morganist]

Quote from achilles28:

Yes, it's good. I think your formal education exceeds mine. But I have learned much of the formal stuff isn't all that practical, or relevant. I made one note above. Lowered rates encourage credit growth? Albeit, which is less destructive than outright monetization, because it's a debt instrument, with a maturity date, expected to be repaid, and therefore, destroyed. etc. ? Perhaps I read it wrong?

Thanks. Also it should be increase not reduction in money supply when interest rates are lowered. I ammended it.

There is a difference between debasement and rates. Which is When money supply is increased through interest rates the currency value is changed by the volume of money supply and the impact it has on exchange rates. When money supply is increased through QE the integrity of the currency itself is questioned decreasing value.

Do you think I should add that to the article?