How Inflation Works (NYT)

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EvelynTroy
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How Inflation Works (NYT)

Post by EvelynTroy » Thu Feb 15, 2018 8:39 am

How Inflation Works -- or Why Your Chicken Is Going to Cost More

https://www.nytimes.com/interactive/201 ... rices.html

Very nice explanation - clear examples. Its not an academic whitepaper - its an article that is very understandable.
My eyes did not gloss over - a very good sign.

Evelyn

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Re: How Inflation Works (NYT)

Post by TOJ » Thu Feb 15, 2018 8:45 am

What I don't understand is how we've had 0 inflation for quite awhile now, which was below what the fed wanted. Now that it has unpegged from 0, there is worry. From the article in the OP: "The fear now is that inflation will start to rise more quickly, potentially crimping global growth or forcing borrowing costs higher. "

So the fed has worked tirelessly to raise inflation to an arbitrary target, and now that they are beginning to get what they want, we now all understand that this could crimp growth.

EDIT: Great article by the way. Thanks for sharing.

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Re: How Inflation Works (NYT)

Post by saltycaper » Thu Feb 15, 2018 9:00 am

TOJ wrote:
Thu Feb 15, 2018 8:45 am
What I don't understand is how we've had 0 inflation for quite awhile now...
We haven't had zero percent inflation. It was negative for a while in 2009 and near zero/negative in 2015, but otherwise it has been positive.
Quod vitae sectabor iter?

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Re: How Inflation Works (NYT)

Post by TOJ » Thu Feb 15, 2018 9:04 am

saltycaper wrote:
Thu Feb 15, 2018 9:00 am
TOJ wrote:
Thu Feb 15, 2018 8:45 am
What I don't understand is how we've had 0 inflation for quite awhile now...
We haven't had zero percent inflation. It was negative for a while in 2009 and near zero/negative in 2015, but otherwise it has been positive.
My mistake. How many years has it been below target?

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Re: How Inflation Works (NYT)

Post by saltycaper » Thu Feb 15, 2018 9:20 am

TOJ wrote:
Thu Feb 15, 2018 9:04 am

My mistake. How many years has it been below target?
I think it was below target in 2009-2010 and 2013-2016.
Quod vitae sectabor iter?

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market timer
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Re: How Inflation Works (NYT)

Post by market timer » Thu Feb 15, 2018 9:25 am

While this is a decent intro on short run inflation dynamics, the article ignores the key drivers of the long run inflation rate and expectations: monetary and fiscal policy. When you run large deficits, you should expect inflation. People are concerned about inflation now for several reasons: (1) unemployment is low; (2) asset prices are high, people feel rich; (3) government is embarking on expansionary fiscal policy despite an already strong labor market.

I'd also add that economists are divided on how the Fed should respond to an uptick in inflation. Some would argue for higher interest rates, which tends to deflate asset prices and reduce aggregate demand. Others argue that higher interest rates will actually cause higher inflation. In other words, it's not clear the Fed even knows what to do to achieve its target.

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Re: How Inflation Works (NYT)

Post by 3CT_Paddler » Thu Feb 15, 2018 9:36 am

market timer wrote:
Thu Feb 15, 2018 9:25 am
I'd also add that economists are divided on how the Fed should respond to an uptick in inflation. Some would argue for higher interest rates, which tends to deflate asset prices and reduce aggregate demand. Others argue that higher interest rates will actually cause higher inflation. In other words, it's not clear the Fed even knows what to do to achieve its target.
What is the reasoning behind the idea that higher interest rates will cause higher inflation?

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Re: How Inflation Works (NYT)

Post by Accrual » Thu Feb 15, 2018 9:36 am

Thanks for linking the article.

It made me think of my Econ 101 professor and his attitude that inflation, when controlled through fiscal/monetary policy, is good. The real worry is deflation.

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Re: How Inflation Works (NYT)

Post by market timer » Thu Feb 15, 2018 10:06 am

3CT_Paddler wrote:
Thu Feb 15, 2018 9:36 am
market timer wrote:
Thu Feb 15, 2018 9:25 am
I'd also add that economists are divided on how the Fed should respond to an uptick in inflation. Some would argue for higher interest rates, which tends to deflate asset prices and reduce aggregate demand. Others argue that higher interest rates will actually cause higher inflation. In other words, it's not clear the Fed even knows what to do to achieve its target.
What is the reasoning behind the idea that higher interest rates will cause higher inflation?
From the Fisher equation, nominal interest rates = real interest rates + inflation. In the long run, the real interest rate is determined by economic growth, not Fed policy. Therefore, if the Fed keeps the nominal rate low for a long time, then inflation will come down. That describes the past 10 years pretty well.

The two main proponents of this Neo-Fisherian theory are John Cochrane and Stephen Williamson:

https://johnhcochrane.blogspot.com/2016 ... model.html
https://faculty.chicagobooth.edu/john.c ... fisher.pdf
http://newmonetarism.blogspot.com/2018/ ... ation.html
http://newmonetarism.blogspot.com/2016/ ... isher.html

Personally, I think the logic is sound for the long run steady state. However, aggregate demand is influenced by asset prices in the short run, which means higher rates could weigh on inflation in the short run if they cause asset prices to fall. Also, the Neo-Fisherian theory ignores fiscal policy, which I think is an important component of inflation as well. Cochrane has a Fiscal Theory of the Price Level that is very intuitive and tries to model the effect of fiscal policy; however, it has essentially no empirical support. Ultimately, a grand theory of inflation needs to integrate both monetary and fiscal policy, along with short run dynamics and long run steady state.

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Re: How Inflation Works (NYT)

Post by BigMoneyNoWhammies » Thu Feb 15, 2018 10:06 am

TOJ wrote:
Thu Feb 15, 2018 9:04 am
saltycaper wrote:
Thu Feb 15, 2018 9:00 am
TOJ wrote:
Thu Feb 15, 2018 8:45 am
What I don't understand is how we've had 0 inflation for quite awhile now...
We haven't had zero percent inflation. It was negative for a while in 2009 and near zero/negative in 2015, but otherwise it has been positive.
My mistake. How many years has it been below target?
The Fed target is 2.0% for inflation. It's poked slightly above this on occasion in recent years for short amounts of time, but in general it has fallen short of the Fed target post-recession. From what I can gather reading the Fed minutes after their meetings every quarter, there isn't necessarily a consensus within the Federal Reserve Board on why this is the case.

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Re: How Inflation Works (NYT)

Post by nisiprius » Thu Feb 15, 2018 10:11 am

Inflation is good for debtors and bad for creditors.

This is obvious, yet often not pointed out. The New York Times article fails to mention it, for example. I don't see it mentioned yet in this thread.

We bought a house in the mid-1970s and the monthly mortgage payments, initially a heavy burden, gradually lightened until they were only slightly more than a nuisance. The reason was that I was getting big-in-dollar-number raises every year. They didn't seem big, in fact it all seemed very stressful at the time, because during the year all the grocery bills and everything else kept rising visibly, and by the time salary review came around we were feeling a nasty pinch and quite worried about whether the raise would be enough to to relieve it.

All economic policies have winners and losers. Hyperinflation and financial collapse are bad for (almost?) everyone, but inflation itself isn't.

As a retiree, I am currently a creditor. Inflation is bad, bad, bad. For me.
Last edited by nisiprius on Thu Feb 15, 2018 10:14 am, edited 4 times in total.
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Re: How Inflation Works (NYT)

Post by Pajamas » Thu Feb 15, 2018 10:11 am

Official statistics are fairly far removed in their effect on my own expenses, but a direct and easy measure for me is the rate of increase in the monthly fees for my apartment, which go up annually to reflect increases in expenses. It's a fairly diverse basket of expenses that includes everything from mortgage interest to insurance; property taxes to salary and benefits for employees; legal, accounting, and other professional fees; oil & gas and utilities; supplies; construction costs, etc. It has increased at a fairly steady clip almost without exception for decades.

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Re: How Inflation Works (NYT)

Post by jebmke » Thu Feb 15, 2018 10:17 am

nisiprius wrote:
Thu Feb 15, 2018 10:11 am
As a retiree, I am currently a creditor. Inflation is bad, bad, bad. For me.
I just started a non-COLA DB pension this year. The low inflation over the last 10 years since I retired have put me slightly ahead of where I expected to be at this point. An uptick in inflation is very bad for retirees with DB pension plans that are not adjusted for inflation.

Fortunately some of my major expenses have been escalating even less than the inflation rate.
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Re: How Inflation Works (NYT)

Post by 3CT_Paddler » Thu Feb 15, 2018 10:26 am

market timer wrote:
Thu Feb 15, 2018 10:06 am
3CT_Paddler wrote:
Thu Feb 15, 2018 9:36 am
market timer wrote:
Thu Feb 15, 2018 9:25 am
I'd also add that economists are divided on how the Fed should respond to an uptick in inflation. Some would argue for higher interest rates, which tends to deflate asset prices and reduce aggregate demand. Others argue that higher interest rates will actually cause higher inflation. In other words, it's not clear the Fed even knows what to do to achieve its target.
What is the reasoning behind the idea that higher interest rates will cause higher inflation?
From the Fisher equation, nominal interest rates = real interest rates + inflation. In the long run, the real interest rate is determined by economic growth, not Fed policy. Therefore, if the Fed keeps the nominal rate low for a long time, then inflation will come down. That describes the past 10 years pretty well.

The two main proponents of this Neo-Fisherian theory are John Cochrane and Stephen Williamson:

https://johnhcochrane.blogspot.com/2016 ... model.html
https://faculty.chicagobooth.edu/john.c ... fisher.pdf
http://newmonetarism.blogspot.com/2018/ ... ation.html
http://newmonetarism.blogspot.com/2016/ ... isher.html

Personally, I think the logic is sound for the long run steady state. However, aggregate demand is influenced by asset prices in the short run, which means higher rates could weigh on inflation in the short run if they cause asset prices to fall. Also, the Neo-Fisherian theory ignores fiscal policy, which I think is an important component of inflation as well. Cochrane has a Fiscal Theory of the Price Level that is very intuitive and tries to model the effect of fiscal policy; however, it has essentially no empirical support. Ultimately, a grand theory of inflation needs to integrate both monetary and fiscal policy, along with short run dynamics and long run steady state.
Thanks for that dense morsel MT... I am going to have to pack a lunch to wade through that gem. :D

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Re: How Inflation Works (NYT)

Post by JBTX » Thu Feb 15, 2018 1:26 pm

I skimmed the article, while much is true it really ignores the monetary underpinnings of inflation. Ultimately inflation is a monetary phenomenon of more money chasing the same amount of goods and services. Most of those things don’t happen unless combined with an expansionary money supply. However money is very hard to measure so controlling money supply is much easier in theory than in practice.

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Re: How Inflation Works (NYT)

Post by Tanelorn » Thu Feb 15, 2018 2:27 pm

nisiprius wrote:
Thu Feb 15, 2018 10:11 am
Inflation is good for debtors and bad for creditors.

This is obvious, yet often not pointed out.... All economic policies have winners and losers.

As a retiree, I am currently a creditor. Inflation is bad, bad, bad. For me.
Exactly. And as is even more rarely pointed out, deflation would be good, good, good for you as a creditor - its like a tax free raise in your retirement spending power. At least until whoever you were lending to started to default because their repayment ability was pegged to nominal dollar wages and started going down while their fixed rate debt payments did not.

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Re: How Inflation Works (NYT)

Post by thx1138 » Thu Feb 15, 2018 2:49 pm

nisiprius wrote:
Thu Feb 15, 2018 10:11 am
Inflation is good for debtors and bad for creditors.
Hey, you are usually more precise than that! Miss your morning coffee :happy

Creditors and debtors are indifferent to inflation because naturally the nominal rate charged for credit takes into account inflation.

What you mean is *unexpected increases* in inflation is good for debtors and bad for creditors.
This is obvious, yet often not pointed out. The New York Times article fails to mention it, for example. I don't see it mentioned yet in this thread.
Well as pointed out it really isn't obvious because as you stated it above was in fact not right. How it matters is actually a bit more subtle and probably beyond the scope of the NYT article.
We bought a house in the mid-1970s and the monthly mortgage payments, initially a heavy burden, gradually lightened until they were only slightly more than a nuisance. The reason was that I was getting big-in-dollar-number raises every year. They didn't seem big, in fact it all seemed very stressful at the time, because during the year all the grocery bills and everything else kept rising visibly, and by the time salary review came around we were feeling a nasty pinch and quite worried about whether the raise would be enough to to relieve it.
Again, unexpected inflation was the problem, not inflation in general.
All economic policies have winners and losers. Hyperinflation and financial collapse are bad for (almost?) everyone, but inflation itself isn't.
Indeed.
As a retiree, I am currently a creditor. Inflation is bad, bad, bad. For me.
Inflation doesn't matter to you as long as your income streams have an expected real return. Since most FI is nominal indeed unexpectedly low inflation tends to be beneficial to retirees and unexpectedly high inflation tends to be bad. That said depending on ones AA a retiree might find deflation to be pretty catastrophic though (e.g. higher stock allocation along with FI in TIPS and corporate bonds rather than CDs and nominal treasuries).

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Re: How Inflation Works (NYT)

Post by Dale_G » Thu Feb 15, 2018 7:14 pm

It is not only unexpected inflation that is damaging to retirees, but plain old expected inflation - including planned or hoped for inflation by the FRB.

I retired at the end of 2001 with a small pension. Call it $1,000 per month. Inflation has averaged almost exactly 2% per year since then. My buying power is now $731/month or $12,000/yr at inception to $8,770/yr today. But the buying power loss has been cumulative, so the total loss in buying power over the years amounts to about $27,800. No surprises, nothing unexpected, just a relatively slow grinding down of purchasing power.

And I am not even cranky today :D

Dale
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Re: How Inflation Works (NYT)

Post by thx1138 » Fri Feb 16, 2018 11:36 am

Dale_G wrote:
Thu Feb 15, 2018 7:14 pm
It is not only unexpected inflation that is damaging to retirees, but plain old expected inflation - including planned or hoped for inflation by the FRB.

I retired at the end of 2001 with a small pension. Call it $1,000 per month. Inflation has averaged almost exactly 2% per year since then. My buying power is now $731/month or $12,000/yr at inception to $8,770/yr today. But the buying power loss has been cumulative, so the total loss in buying power over the years amounts to about $27,800. No surprises, nothing unexpected, just a relatively slow grinding down of purchasing power.
Absolutely agree but didn't do a good job explaining as such at the end of my post.

A creditor/debtor tends to not care much about expected inflation as the nominal rates will be set to account for that, which was what I was primarily addressing. For creditor/debtor what primarily matters is unexpected inflation.

For a retiree though, as I mentioned, what matters if you get an expected and predictable real rate of return. Many FI instruments return in nominal dollars and if inflation goes "as expected" then that nominal return translates to a predictable real rate of return. Some annuities have a fixed increase in nominal dollars, so essentially an "expected" rate of inflation. Both those cases are similar to the creditor/debtor, as long as inflation goes "as expected" all is well.

As you point out though, some pensions are just plain nominal dollars with no real or nominal adjustment over time! This as you say means any sort of inflation is constantly reducing the purchasing power of that income stream. Another way to look at it is that the pension has made a ridiculously unreasonable expectation of zero inflation and so any amount of inflation is "unexpected". ;)

The lack of any really practical low cost options for inflation adjusted annuity streams beyond SS or certain pensions is a huge hole in the whole "defined contribution" model we've been moving towards. It essentially forces a retiree to maintain some allocation in assets that have a better chance of tracking inflation but in general those end up with either extremely low returns with no mortality credits to offset the low return (e.g. TIPS) or the addition of pretty severe sequence of returns risks in order to get a higher expected real return (e.g. equities).

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Re: How Inflation Works (NYT)

Post by Valuethinker » Fri Feb 16, 2018 5:28 pm

JBTX wrote:
Thu Feb 15, 2018 1:26 pm
I skimmed the article, while much is true it really ignores the monetary underpinnings of inflation. Ultimately inflation is a monetary phenomenon of more money chasing the same amount of goods and services. Most of those things don’t happen unless combined with an expansionary money supply. However money is very hard to measure so controlling money supply is much easier in theory than in practice.
There's 2 problems with the simple monetary theory of inflation:

- money GDP = quantity of money x velocity of money

Velocity of money is not controllable. Go back to the "lending corset" of UK Chancellors of the postwar years, trying to direct and control where banks lend money, for an example. Monetary velocity rises and drops with economic activity, thus, in the 1930s, it dropped sharply and did not recover.

So you have this variable which is only indirectly observable and is not stable over time, which is just as important in determining inflation as the quantity of money

- (which you mention) the modern financial system can create new forms of money and near money. Thus (former Chief Economist of the Bank of England) "Goodhart's Law" that the usefulness of a measure of money varies inversely with the degree to which it is controlled.

I lived through the experiments with extreme monetarism in the UK, Canada and USA in early 1980s. The Central Banks would target M1, then M1a, then M2, then M2b, then M4 ....

In fact the evidence is that the CBs never believed in Friedman's monetary theories. What it did do was give them an intellectual justification, top cover, for their efforts to crush inflation in the old fashioned way.

To wit: jack up interest rates until the economy has slack resources (read that as: consumers don't spend, companies and individuals go bust, there is unemployment and spare productive capacity) which in turn drives down inflation.

The cost, if you lived in the US "Rust Belt" or British industrial areas, was just awful. Britain reached 3 million unemployed by the mid 1980s (a little over 1 million in the last Crash, which was every bit as bad in GDP terms). Lots of people and communities have never recovered. Not coincidentally, it is when the disability rate for men without college education started to soar-- in effect, the industrialized world chose to pay those men off and register them as disabled, as part of the price for controlling inflation and breaking the trade unions.

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Re: How Inflation Works (NYT)

Post by Valuethinker » Fri Feb 16, 2018 5:33 pm

EvelynTroy wrote:
Thu Feb 15, 2018 8:39 am
How Inflation Works -- or Why Your Chicken Is Going to Cost More

https://www.nytimes.com/interactive/201 ... rices.html

Very nice explanation - clear examples. Its not an academic whitepaper - its an article that is very understandable.
My eyes did not gloss over - a very good sign.

Evelyn
the Fed uses a quite simple model of the economy to guide interest rate policy.

It measures the "output gap" between its estimate of the theoretical productive capacity of the economy, and actual GDP.

As long as that gap is positive (there exist slack resources) low interest rates will not cause inflation.

When the economy moves back to full employment (traditionally held to be 4.5% unemployment rate*, although there are some reasons to believe it might now be lower) then the Fed gets worried about rising inflationary pressures, and raises interest rates to get the economy towards "equilibrium".

Historically you can predict the Fed's actions fairly well using the "Taylor Rule" which is as described above.

* NAIRU Non Accelerating Inflation Rate of Unemployment. To complicate things, the Fed uses an "Expectations adjusted" calculation, which takes into account their estimates of the market's future inflation expectations.

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Re: How Inflation Works (NYT)

Post by Top99% » Sat Feb 17, 2018 12:17 pm

Dale_G wrote:
Thu Feb 15, 2018 7:14 pm
It is not only unexpected inflation that is damaging to retirees, but plain old expected inflation - including planned or hoped for inflation by the FRB.

I retired at the end of 2001 with a small pension. Call it $1,000 per month. Inflation has averaged almost exactly 2% per year since then. My buying power is now $731/month or $12,000/yr at inception to $8,770/yr today. But the buying power loss has been cumulative, so the total loss in buying power over the years amounts to about $27,800. No surprises, nothing unexpected, just a relatively slow grinding down of purchasing power.

And I am not even cranky today :D

Dale
And within the two types of inflation (expected and unexpected) there are two sub-types:
1) Inflation in the prices of the basket of goods and services measured by CPI
2) Inflation in the prices of the basket goods and services that match *your* expenses.
As a retiree I probably won't care if housing and car prices rise. Food and healthcare on the other hand... The scariest thing would be unexpected inflation in 2) because TIPS and the SS COLA won't help you much if the CPI is way below your personal inflation rate.
You need some combination of a very large nest egg realative to your expenses and at least part of your nest egg earning returns higher than CPI measured inflation.
Adapt or perish

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