Does high inflation matter?
It started in America, but the spike in inflation has spread to the rest of the rich world. Consumer prices throughout OECD the club of mostly rich countries is growing at 10.3% annually, the fastest growth rate in at least three decades. In the Netherlands, inflation is approaching 12% even higher than in America, and in Estonia more than 22%. How strongly should central banks respond to a spike in inflation? The answer depends on how much damage inflation does. And it depends on who you ask.

Inflation is considered costly because it erodes people’s savings and distorts price signals. And there are undeniably cases where it brought the economy to its knees. During a period of hyperinflation in Weimar Germany in the 1920s, people’s savings evaporated, eliminating the middle class and paving the way for the rise of fascism. Inflation was also out of control in Zimbabwe under Robert Mugabe. When price signals failed, millions went without food.

But in more moderate inflationary episodes, such as the current one, the evidence for economic carnage is weaker. A common concern is that price increases are outpacing wage increases, causing people’s real incomes to fall. This has almost certainly happened in rich countries in recent months. US real hourly earnings fell 3.6% in the year to June.

However, in general, economists see a weak link between inflation and the real standard of living of workers. Sometimes prices rise faster than wages; sometimes they don’t. British real wages rose strongly during the inflationary era of the 1970s. According to a study published in 1975, American workers, whether they were union members or not, had faced inflation-busting wage increases in the previous decade. Economist reviewed data for 35 OECD in countries since 1990. In years when inflation exceeded 5%, we found that real wages rose on average. Inflation can also help the unemployed find work, even if it hurts people who are already working. After the global financial crisis of 2007-09, the pound depreciated, raising inflation in Britain and reducing real wages. Then companies could afford to hire more workers.

The idea that inflation distorts price signals, another putative economic cost, is also exaggerated at moderate levels. Capitalism allocates resources through changes in relative prices: if the price of a car rises relative to the price of a bicycle, eventually more cars must be produced. The worry is that inflation distorts this process, making it harder to discern the “true” relative prices of cars and bikes.

However, in a paper published in 2018, Amy Nakamura of the University of California, Berkeley, and colleagues examine the price dispersion of the same products over time. Looking at a period of high inflation in the 1970s, they find “no evidence that prices deviated more from their optimal level” than just before the pandemic, when inflation was much lower. “Known conclusions about [the] the optimality of low inflation rates [in this regard] need to be reconsidered,” they conclude.

Sophisticated papers like these support a wider body of work going back decades that questions the link between inflation and growth. Document published imf in 2014 noted that “few empirical studies have even attempted to find the cost of single-digit inflation.” In 1996, Michael Bruno and William Easterly, then both of the World Bank, found “no evidence of any relationship between inflation and growth at annual inflation rates below 40%”. The following year, Paul Krugman wrote that “although inflation is widely regarded as a terrible scourge, attempts to measure its cost lead to embarrassingly small numbers.”

So does the current bout of inflation in the rich countries have minimal or no cost at all? The problem with economists is that there is a world outside of their research. Few people know and care about their results. But they know what they think about inflation: they absolutely, relentlessly hate it.

Inflation seems to have a special place in the public mind. Our analysis of English-language newspapers and blog posts shows that in the 2010s, media organizations mentioned inflation 50% more often than unemployment, even though unemployment was a much bigger economic problem in that decade. In the 1990s, Robert Shiller of Yale University asked people in a number of countries about their views on inflation and compared them with the views of economists. He found that ordinary people hold much more extreme views on the subject than the scientists who make their living studying it.

People believe that inflation makes them poorer. They worry that it complicates planning. And they believe that inflation is a sign that unscrupulous companies are taking advantage of them (two-thirds of Americans attribute the recent rise in inflation to corporate greed). Economists, on the contrary, are more unambiguous in their answers. More than half of Americans “strongly agreed” that preventing high inflation is as important as stopping drug abuse or maintaining educational standards, compared with just 18% of economists. In the same poll, Mr. Shiller found that 46% of people would want the government to lower the price level after a spike in inflation (ie to create deflation), which few economists would recommend.

Get real

Maybe politicians should just ignore the views of ordinary people. If experts find that inflation has surprisingly low costs, what additional information is needed to guide policy? Another way of looking at it, however, is that the psychological costs of high inflation are real, and that central bankers and governments need to take them into account. Combating inflation by severely tightening fiscal or monetary policy is often seen as a harsh choice because it cools the economy and risks provoking a recession. In fact, this is one of the most populist policies.


Source: https://newslivewashington.com/ ; https://www.economist.com/

Fill out the form and get your FREE Research Report

Developed by WEO