Saturday, May 14, 2011

Paul Krugman Thinks He Is On a Plane Landing at 3.6% Price Inflation

Here's Paul Krugman from November 2010:
There’s really nothing here to shake my view that deflation, not inflation, is the threat.

Now Krugman says, well there is inflation, but it's no big deal:
Oh, and about commodity prices: rises on the order of what we’ve seen lately aren’t at all unusual, even during periods now considered to have been characterized by low and stable inflation...Just not something to get frantic about.

He also says that one needs to put in perspective the current CPI increase:
Now I get a lot of mail from people saying, “You say inflation is not a problem — but consumer prices rose 3.1 percent over the past year.”Again, it’s useful to have some perspective.

So, here’s consumer price inflation since 1985 — that is, after the Volcker disinflation, and after morning in America and all that:

Now, Krugman is trying to prove by this chart that 3.6% price inflation is no big deal. But this is where Krugman in his aggregate thinking fails to take into account the complexities of the economy. But before I get to the current price inflation, it's instructive to look at the above and start with the early 2000's. The Austrian economic school position was that although price inflation wasn't extremely high in the early 2000's, Fed money pumping was setting up a crash. Something that you could not have according to traditional Keynesian theory---and the reason Bernanke and most non-Austrians missed the crisis. The failure to understand the disaggregated economy gets Krugman and most non-Austrians caught in all kinds of jams.

Krugman is now  saying that 3.6% inflation is no big deal, but again he fails to look at the complexities of the economy and the factors surrounding the 3.6% number.  First as the chart clearly shows, during the financial crisis, you had a dramatic drop in price inflation. This can be explained by the fear about the economy and the desire by the public to increase cash balances. But now that fear is receding as evidenced by the University of Michigan Consumer Sentiment Index:

This increase in consumer sentiment suggests that the desire to hold cash balances is falling, which will add price pressure in the economy.

At the same time, money supply is increasing:

So you basically have a situation where the two main drivers of price inflation, the decreasing demand to hold cash balances and increasing money supply growth are climbing. It makes no sense to do what Krugman is doing, i.e., just look at the absolute number and say, "No big whoops about price inflation. It's only at 3.6%". You have to look at the factors driving the CPI and what direction they are headed in. And it's clear that at this point these factors are pointing to climbing price inflation.

For Krugman to look at the current absolute number without considering the direction of the move or the driving factors behind the move would be like him getting on a plane in NYC that is headed for Los Angeles and spotting, about half way through the trip, the St Louis Gateway Arch and then being adamant that the plane was landing in St Louis, because he spotted the Gateway Arch.

Yeah Paul, you have spotted a 3.6% climb in the CPI, just after declaring months ago that deflation was the real concern, but your biggest mistakes are still ahead. This price inflation jet is is fueled for a lot longer run. This plane isn't landing anywhere near 3.6%. My ticket says landing in double-digit price inflationary territory.

1 comment:

  1. I just wonder how he's gonna squirm out of this one.