Thursday, June 11, 2009


Is "the Market" Forecasting Inflation?

* Let's be frank: Those of us who expect significant price inflation--and very soon--are disagreeing with the market "consensus" as gauged by market prices. But this shouldn't be a deal breaker. After all, "the market" incorrectly forecast real estate prices for years, and the same for oil prices in the summer of 2008. If I think there is currently an asset bubble in US Treasurys, you don't dispose of the argument merely by saying, "If you are right, why aren't people shorting Treasurys?"

* Von Pepe sends this two-handed (you'll see what I mean) Cleveland Fed paper on using TIPS yields to back out "the market's" inflation forecast. They hem and haw a lot, but I think they are saying that inflation expectations in the mid-term have risen sharply since late 2008. (However, in an absolute sense they are still tame.)

* What really reassures me in my inflation outlook is today's CNBC article, which quotes several "experts" who say I'm crazy. When learned market watches merely say I'm misdiagnosing the danger, that's fine, maybe they're right. But to say that inflation worries are "insane"? Nah, that sounds like housing boom talk.

After reading those comments from those no-name "experts," I am now reassured that inflation is not a likely possibility...
What I dont understand - everyone thinks of inflation as an increase in prices. That's their definition of inflation, where I have always thought of inflation as an increase in the money supply. So why is there such a disconnect in definitions? Am I wrong in my definition, or too narrow-minded?

Thus, although higher prices may result from inflation it is not a necessary condition of inflation. Again, am I wrong in my assumption?

It's just a difference in definitions. The more traditional usage is the one you use: increase in money supply = inflation.

My guess: the Keynesian Revolution was what led to a redefining of the term. Under traditional Classical Quantity Theory, monetary inflation and price inflation go hand-in-hand, more or less. Under Keynesian theory this is no longer true. The liquidity trap, for example, offers a case where the money supply can grow a lot with little to no impact on prices. Economists today are generally more concerned with the problems caused by rising (or falling) prices - regardless the reason for that rise - than with problems caused by increasing (or decreasing) the supply of money.

Anyway, as far as being "wrong" in your definition... I don't think a definition can be "right" or "wrong". Rather, a definition is simply "useful" or not. Personally, I prefer your definition over the usual one, though I generally try to use either "price inflation" or "monetary inflation" just for clarity.

What Lucas said.
If anyone's still following:

One other sign of "false reassurance" is when they start talking about specuation of bad stuff as being "not helpful", especially "not helpful right now".


Newbie Reporter: Mr. Wagoner, is there a change GM could simply declare bankruptcy, given that there's no ****ing way it could possibly fulfill its obligations?

Wagoner: Talk of bankruptcy is not helpful at this point.


Btw, here's some hasty, novice speculation on Keynesianism and the different kinds of inflation. I think Keynes ignores the role that liquidity "prices" play. The reason money-inflation can be so de-correlated from price-inflation is that there can be times when that money "doesn't move", so the value of "stuff" right now isn't very high.

But then people may all suddently decide to spend their hoarded dollars, and then the market will respond with higher prices. So the higher quanitity must "reveal itself" at one point, but no one knows when.

People holding money in "demand" deposits expect to pay less for their liquidity (during "credit crunches") than that liquidity is actually worth. Keynesians roll their eyes at the idea that one demand deposit dollar might truly be worth less than one printed dollar, and so see no harm in simply filling the gap.

But that "price of liquidity" is a real market signal, which coordinates real activity, and so on.
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