Wednesday, July 24, 2013

The Improper Use of Historical Data in Economics: An Example (From, who else, Paul Krugman)

Paul Krugman is out with a blog post titled, The Death of High Inflation. He writes (my bold):
As a number of people have been reminding us lately, talk of high inflation, nay hyperinflation, has been widespread ever since the Fed began trying to fight the Great Recession. And the failure of the predicted high inflation to appear has done nothing to shake their conviction that they have the truth, and that those of us who have been right are nonetheless wrong.

So, one thing I wonder about is the extent to which this attitude is reinforced not just by the usual crank tendencies, right-wing leanings, and so on, but also by the fact that economists love — looooove — to talk about runaway inflation, precisely because it’s something that’s so easy to explain: you run the printing presses to cover your deficits, and off you go.

Yet this is getting awfully stale.Not only has the promised high inflation failed to appear here in America, but high inflation has largely vanished everywhere.

I did a quick calculation using the IMF’s World Economic Outlook Database, which runs back to 1980. Year by year, how many countries had triple digit inflation in any given year? It looks like this: 

Basically, there was a wave of hyperinflations caused by the chaos following the breakup of the Soviet Empire, much like the wave after World War I; since then, Zimbabwe and nobody else.

Even double-digit inflation has become quite rare:

There’s a brief spike around 2008; if you look at it, it turns out to be mainly small commodity-exporting countries pushed into big devaluations by the crisis, leading to one-time jumps in consumer prices. But then it was back to the downward trend.

There are, I think, a couple of morals here. One is that economics textbooks probably talk too much about high inflation; it’s a nice pedagogical set-piece, but not something that’s a real issue in today’s world.
First, just because something isn't a regular everyday occurrence doesn't mean it isn't something one shouldn't be prepared for. Hurricanes don't hit New Orleans everyday. On average, only one major hurricane crosses within 100 nautical miles of New Orleans every decade. but just ask people in the Big Easy about Hurricane Katrina and the danger of not preparing for the big one

Second, Krugman is implying that just because something wasn't a big deal yesterday, it won't be a big deal tomorrow. That's what he means when he says high inflation is "not something that’s a real issue in today’s world,"  and uses his empirical charts to make his claim.But this is just bad methodology. In the world of economics, just because something hasn't occurred before, doesn't mean it won't occur in the future. There are no mathematical constants.

Here's the price of gold from 1980 to 2000, it was in steady decline for two decades. By Krugman logic a rising gold price would "not [be] something" that would have been a "real issue".

Of course, we all know what occurred after the year 2000.

In the science of economics, historical data can never tells us what will happen tomorrow. It is bad methodology to think it will. It is the methodology that blew up Long Term Capital Management and the su-prime mortgage market. Krugman is just using this bad methodology on a grander sale, to create grander nonsense.


  1. If you are preparing for inflation, why not also prepare for deflation? Don't lend or borrow.

  2. Jay, do even know what deflation is?