(Alexander William Salter, American Institute for Economic Research) The battle between inflation hawks and doves is heating up.
TheĀ year-over-year changeĀ in the Consumer Price Index is 5.4%, significantly above average. This figure, from the end of July, comes after several months of economy-wide price hikes.
But does this portend high inflation for the foreseeable future? Or, will inflation come back down soon? Furthermore, whatās at stake in this debate?
AtĀ National Reviewās Capital Matters page, Ramesh PonnuruĀ helpfully breaks downĀ the differences between #TeamEndemic and #TeamTransitory. Like Ramesh, Iām #TeamTransitory. As supply-side bottlenecks continue to ease, production will pick up and prices will slow their rate of increase.
The Fed isĀ increasingly signalingĀ that it will taper off its asset purchases, which complements supply-side disinflationary forces with demand-side disinflationary policy.Ā Market forecasts of inflationĀ years into the future also predict inflation falling back to levels closer to the historical average.
Itās understandable that people are starting to panic about inflation, especially workers who havenāt seen their wages keep pace with price growth elsewhere in the economy. Real (meaning inflation-adjusted) wages are indeed falling. But this wonāt last forever. You usually canāt renegotiate wages as often as output prices, which is why nominal (meaning current-dollar valued) and real wages diverge in the short run.
But once contract periods expire, workers should be able to bargain for compensation in the neighborhood of the value they add to the production process. Unless there have been permanent changes to labor productivity, inflationary reductions in real wages are temporary.
This is small consolation to those having a harder time making ends meet. They might feel like theyāre being robbed. Itās important to realize, however, that the implicit redistribution taking place isnāt between workers and government. Itās between workers and employers.
Higher-than-anticipated inflation means businesses are temporarily getting cheaper labor. Since final goods and services prices are rising, businesses are getting a windfall. The losses to workers probably balance the gains to employers, meaning thereās little if any inefficiency on net.
Government only makes money on inflation to the extent everyone in the economy continues to hold cash. If they diversify their wealth into other assets, the government wonāt be able to transfer much purchasing power to itself by creating money.
Economists call the revenues from money creation āseigniorage,ā a throwback to when issuing money was the prerogative of the nobility (seigneurs). Whatever Uncle Sam is making in seigniorage, it pales in comparison to, say, federal tax revenues. If citizens are getting robbed, it isnāt by the Fed.
Whatās worrisome about inflation isnāt its magnitude, but its predictability. The noisier the pricing process, the harder it is for producers and consumers to coordinate with each other. Hereās the real inefficiency from inflation: when itās hard to forecast, we have to devote more resources to protecting ourselves against it. That means less wealth to enjoy in other ways.
Whether the purchasing power of the dollar is predictable depends on whether the central bank is rule-bound. The Fed isnāt.
As mentioned, it does have an average inflation target, meaning it shoots for 2% inflation on average, over the long run. But this isnāt very reassuring. First, the rule is self-chosen, which means if push comes to shove, itās unlikely to bind. Second, the Fed is giving itself leeway to make mistakes today by promising to make up for mistakes tomorrow.
This is only beneficial if the Fed is a competent monetary manager. For anyone whoās been paying attention to monetary policy in the 21st century, ācompetentā isnāt among the list of adjectives that plausibly describes the Fed.
The public debate over inflation is a great opportunity to focus on what really matters:Ā subjecting monetary policymakers to the rule of law. Unfortunately, weāre currently squandering that opportunity to repeat pop-macroeconomic fallacies.
We should care about inflation, but for very different reasons than youāll hear from the āman on the street,ā or economic and financial journalists, for that matter. Policy outcomes, such as inflation, vary from quarter to quarter. Rules and processes are enduring. Letās talk more about the latter and less about the former.
Alexander William Salter is an Associate Professor of Economics in the Rawls College of Business and the Comparative Economics Research Fellow with the Free Market Institute, both at Texas Tech University.Ā