Ms. Yellen And Inflation

No “Inflation Worries”

Ahead of the Jackson Hole pow-wow, where a bunch of central bankers and establishment-approved intellectuals advising them will soon meet, it may be worth taking a look at what motivates the policies of the new Fed chair. On August 12, Bloomberg reported – employing its inimitable style of headlines construction -  that “Yellen resolved to avoid raising rates too soon, fearing downturn”. Bloomberg elaborates:

“Approaching a historic turn in U.S. monetary policy, Janet Yellen has staked her tenure as chair of the Federal Reserve on a simple principle: she’d rather fight inflation than another economic downturn.

Interviews with current and former Fed officials indicate that Yellen and core decision-makers at the U.S. central bank are determined not to raise interest rates too early and risk hurting the fragile U.S. economy.

It’s a commitment that will be vigorously tested in coming months as pressure builds inside the Fed, among Republicans on Capitol Hill, and perhaps even in financial markets, for the Fed to acknowledge a strengthening U.S. economy with its first interest-rate increase in more than eight years. A global central bankers’ conference in Jackson Hole, Wyoming next week will give Yellen a major stage on which to press her case.”

To this it must be kept in mind that the definition of “inflation” has been twisted over time to represent one of its possible effects rather than the thing itself. Prices obviously cannot be “inflated” – they can either rise or fall. What can be inflated is the money supply, and until large parts of the science of economics began to retrogress from the late 1930s onward, this was precisely what economists held to be the meaning of the term. In short, “inflation” once designated the increase in the money supply. However, Bloomberg, Ms. Yellen and her fellow Fed members use the term “inflation” to refer to the mythical “general price level”, specifically the rate of change of consumer prices.

Why is there no such thing as the “general price level”? Even our largely disembodied digital money is essentially a good with its own supply-demand characteristics. If one compares the array of price ratios it forms with other goods against which it is exchanged, there are two problems:

Firstly, since both money and the goods one exchanges it for are subject to the laws of supply and demand, there exists no fixed yardstick – if one e.g. looks at the money price of oil, it is simply not possible to know to what extent its height is influenced by the supply of and demand for money, or the supply of and demand for oil.

The second problem is that by adding up an entire array of money prices of disparate goods, one arrives at a number that is devoid of logic.

To see why consider the following sentence: “1/25,000 of a car, plus one movie ticket, plus two pounds of potatoes, plus one fifth of a massage, plus ½ of a haircut, plus 1/500 of a personal computer, equals….” -  when it is put in this way, it should be immediately obvious what the problem is. An “average” of cars, potatoes, haircuts, etc. is inherently meaningless.

With that out of the way, one may concede that such data points as CPI, in spite of being fundamentally nonsensical numbers, have some limited value to the extent that they indicate general trends in the ever declining purchasing power of today’s money. Unfortunately, CPI data cannot be meaningfully compared over long stretches of time. This is firstly due to the fact that the composition of goods and services that are produced and consumed continually changes (for instance, the 1905 price of buggy whips and gas lamps is entirely meaningless for today’s economy). For another thing, because a wide range of the government’s so-called “entitlement expenditures” are tied to CPI, there has been a strong incentive to fiddle with the formula used to calculate CPI, so as to make CPI rates of change appear as low as possible. If the same formula that was used to calculate it in e.g. 1980 were still used today, economists would probably be in complete agreement that there is in fact an enormous “inflation problem”.