MCViewPoint

Opinion from a Libertarian ViewPoint

Do “Inflationary Expectations” Cause Inflation? Contra Krugman, the Answer Is No

Posted by M. C. on April 9, 2022

So what is the present status of inflation? The official version is that the yearly growth rate of the US Consumer Price Index (CPI) stood at 7.9 percent in February against 7.5 percent in January and 1.7 percent in February 2021. However, in terms of money supply, inflation stood at 7.9 percent in February 2021 against 4 percent in January 2019. Given such massive increases in money supply and given the long time lags from changes in money and changes in prices one should not be surprised that the yearly growth rate of the CPI displays a visible increase.

https://mises.org/wire/do-inflationary-expectations-cause-inflation-contra-krugman-answer-no

Frank Shostak

n the New York Times article “How High Inflation Will Come Down,” Paul Krugman suggests that the key for future inflation is inflation expectations. Krugman does not think that currently inflation expectations are comparable to the 1980s. According to him:

Forty years ago, as many economists will tell you, inflation was “entrenched” in the economy. That is, businesses, workers and consumers were making decisions based on the belief that high inflation would continue for many years to come. One way to see this entrenchment is to look at the wage contracts—typically for three years—that unions were negotiating with employers. Even then, most workers weren’t unionized, but these deals are a useful indicator of what was probably happening to wage- and price-setting more generally.

Furthermore:

So, what did those wage deals look like? In 1979, union settlements with large companies that didn’t include a cost-of-living adjustment specified an average wage increase of 10.2 percent in the first year and an annual average of 8.2 percent over the life of the contract. As late as 1981, the United Mine Workers negotiated a contract that would raise wages 11 percent annually over the next several years…. Why were workers demanding, and employers willing to grant, such big pay hikes? Because everyone expected high inflation to persist for a long time. In 1980 the Blue Chip Survey of professional forecasters predicted 8 percent annual inflation over the next decade. Consumers surveyed by the University of Michigan expected prices to rise by about 9 percent annually over the next five to 10 years. With everyone expecting inflation to continue, workers wanted raises that would keep up with rising prices, and employers were willing to grant those raises because they expected their competitors’ costs to be rising as fast as their own. What this did, in turn, was make inflation self-perpetuating: Everyone was raising prices in anticipation of everyone else raising prices. Ending this cycle required a huge shock—an economy so depressed both that inflation fell and that workers were compelled to accept major concessions.

This time around, Krugman holds, things are different:

Back then almost everyone expected persistent high inflation; now few people do.Bond markets expect inflation eventually to return to pre-pandemic levels. While consumers expect high inflation over the next year, their longer-term expectations remain “anchored” at fairly moderate levels. Professional forecasters expect inflation to moderate next year. This means that we almost surely aren’t experiencing the kind of self-perpetuating inflation that was so hard to end in the 1980s. A lot of recent inflation will subside when oil and food prices stop rising, when the prices of used cars, which rose 41 percent (!) over the past year during the shortage of new cars, come down, and so on. The big surge in rents also appears to be largely behind us, although the slowdown won’t show up in official numbers for a while. So it probably won ‘t be necessary to put the economy through an ’80s-style wringer to get inflation down.

Given all this, Krugman holds, history tells us that we are not moving to rampant inflation as we did in the 1970s:

See the rest here

Be seeing you

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