Sunday, April 10, 2011

Why Mark Perry is Wrong About Inflation

Although he couches it as a question, Can We Have Inflationary Pressures Building in U.S. With Falling Home Prices and 2% Wage Increases?, it appears he falls into the camp that thinks it is unlikely. He writes:
Currently, we've had 22 consecutive months of year-over-year wage increases below 3%, and b) 13 consecutive quarters of negative year-over-year home price increases starting in late 2007. Given the past historical patterns of inflation being accompanied by rising wages and home prices, it seems like the proponents of pending inflation have to explain how inflationary pressures can be building in the economy with: a) falling home prices and b) wage increases of 2% that are less than half the 4.5% average since 1965? It would be historically unprecedented to start experiencing rising inflation in 2011 with falling home prices and stagnant wages, and unless and until we start seeing rising home prices and wages we might not see higher inflation this year.

Here is what Perry is missing. The money flowing into the economy is not going to wage earners, but it is still flowing. It is going to a large degree to Wall Street and secondly to others holding stocks. These capital gains do not show up as wage gains, but this money is out there slowly working its way through the economy and will push up prices. Secondly, the housing market is completely distorted by government intervention since the middle of the crisis. Supply that should have been cleared out many months ago is only now finding its way on to the market. It is this supply that is keeping housing prices low, not a weakening in dollar demand.

Thirdly, during the financial crisis, the United States experienced a huge flight to cash. The demand to hold cash soared, which had a deflationary tendency on prices. That demand to hold cash is now reversing, thus, even if we don't have money printing or an increase in wages, prices can still climb because of the lessening demand to hold cash balances.

Against this background, the Federal Reserve continues to print money which means that, yes, at some point the money will work its way into pushing up wages, but there are plenty of other factors which will push consumer prices up first. And so, consumer prices will climb with wages lagging.


  1. It's almost as if he psychologically *wants* to believe that inflation is only about the poor little guy benefiting from it and being the people who will increasing the demand for consumer goods and thus raising the prices of those goods.

    I think he does not consider the transmission mechanisms you mentioned above because that would compel him to realize that the poor little guy is ripped off by inflation.

  2. Mark Perry seems like a pretty bright guy, I think he knows inflation is bad for the "little guy" and savers in general. He probably just doesn't fully understand the mechanism through which inflation can enter the market. As Robert pointed out, looking at strictly wages and house prices doesn't tell you the full story.

  3. What evidence do you have that people are spending rather than saving?

  4. I didn't say people are saving rather than spending, I said that the demand to hold cash balances is declining---a completely different concept.

  5. Bob:

    I didn't mean to sound as if I was being critical of your comment. Sorry if it came off that way. I agree with your comments on inflation. I read your blog regularly and enjoy it. I do understand what you were saying about inflation. I guess my real question in Misean terms, was what leads you to believe people are reducing cash balances. I understand the issue in these terms:

    During periods of economic uncertainty and deflation, people act rationally by holding on to cash. They can stuff it under the mattress or put it in the bank (more likely). As a result of this increased savings (demand for cash), consumption is reduced, and prices decline, relative to cash in the economy, as demand declines. Alternatively, during periods of inflation, relative to an increasing supply of money, people eventually see a declining dollar in the fact that prices are starting to increase. They act rationally and wish to reduce their cash holdings and acquire goods. Thus they reduce their savings and consume more. Ergo another sign of inflation. Since wages have been rather flat, I see spending from the middle classes to be from savings rather than income gains. I agree with your assessment of the effects of QE in that the money hits the financial markets first and benefit investors. Thus I see a two-tier economy at present with the investors spending because of the market's wealth effect, but the rest of folks are still rather tight with the dollar. But ... we are seeing increasing retail sales which would indicate that people are reducing cash balances, but the savings rate is still high. So my question really is: where do you see the demand to hold cash declining in response to price inflation? Sorry if I came off cranky.

  6. You have to be careful, savings and the desire to hold cash balances are two different things. Holding cash in your wallet is cash balance activity, but not savings. Savings is when you put it in a bank knowing that it will be loaned out (Although, I think there is some cross over).

    As for cash balances increasing, I think you said it yourself, retail sales are increasing. Climbing consumer "confidence" is another riugh indicator. But it is really overall anecdotal type evidence, which makes it a difficult number to quantify and why econometricians tend to ignore it.

  7. I understand the point, but never thought cash in pockets meant much in terms of signaling trends. But you may be right. Net checkable deposits have grown per last Flow of Funds report. But so have time deposit. TMS 1 and 2 are up. So, if it's not coming from wages, then ...