Sunday, December 30, 2012

Private Debt and Modern Cost-Push Inflation

The Arthurian rekindles consideration of Cost-Push Inflation: An Issue Resolved, or Simply Dismissed?:
At The Everyday Economist some months back, Josh Hendrickson captured my attention with his Nominal Income and the Great Moderation. In that post, Hendrickson introduced a forthcoming paper and said:
As I argue in the paper, during the Great Inflation period of the 1970s, members of the FOMC regularly asserted that the process of inflation determination had changed. Relying on public statements and personal diary entries from Arthur Burns, I demonstrate that there is little evidence that the Federal Reserve was less concerned with inflation during the 1970s. Rather, the view of Burns and others was that inflation was largely a cost-push phenomenon. Burns thought that incomes policies were necessary to restore price stability and stated that “monetary and fiscal tools are inadequate for dealing with sources of price inflation that are plaguing us now.”
The shift in policy, beginning with Paul Volcker, was an explicit attempt to stabilize inflation expectations and this was done deliberately at first through monetary targeting and ultimately through the stabilization of nominal income growth. Gone were notions of cost-push versus demand-pull inflation.
I can see a natural progression there: from the thought that "incomes policies were necessary" to policies for "the stabilization of nominal income growth." Incomes policies means wage-and-price controls. The method is crude, but the objective of wage and price controls is precisely "the stabilization of nominal income growth."
Beside the point. What concerns me is "the view of Burns and others was that inflation was largely a cost-push phenomenon." That, and the apparent fact that this issue of cost-push was never resolved. It was simply dismissed.
As with many aspects of science, there is an inherent desire to find one all-encompassing explanation for macroeconomic phenomenon. Maybe it’s naivete, or pragmatism, but there seems little reason to expect one simple reason behind inherently complex phenomena. Returning to inflation, maybe a simple primary cause exists at certain periods of time and in certain locations, but throughout history there may very well be numerous causes.

Approaching the question of inflation from a Keynesian perspective, it seems obvious that demand-led inflation is plausible. Individual’s desire for goods can clearly shift faster than the economy’s ability to produce new output. Similarly, from a Monetarist perspective, one can easily envision an excess supply of money causing a decline in its value that represents an increase in the price level. Or, as Nick Rowe suggests, maybe monopoly power causes inflation.

While all of the above views likely have their time and place, a way to reconcile cost-push inflation with today’s circumstances may not exist within mainstream models. In The Bubble and Beyond, by non-mainstream economist Michael Hudson, a case is made whereby rising interest expenses on debt could generate cost-push inflation. Over the past 30 years, there has been a massive increase in the amount of private debt both at the household and corporate levels. The reliance on debt funding involves interest expenses that push up the cost of production. Since interest expenses can rise at compounding rates, the impact on the overall cost structure becomes larger over time. These effects on inflation may help to explain persistent inflation throughout the recent crisis despite the significant drop in aggregate demand and broad measures of money.

The cost-push inflation of an earlier era may be gone, but the phenomena may still be with us today. The dismissal of private debt and interest expenses from macro models may be the reason the issue of cost-push inflation was “simply dismissed.”   

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