Matt Nolan

The inflation fighting trade-off

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Note: Other posts in this discussion are available under the tag “inflation debate“.

So, after calling on you guys to give me some indication of your views on monetary policy we discussed what inflation is, and then we moved on to discussing the costs that stem from inflation. We are now ready to discuss the big topic – the trade-off between inflation and other things.

I’m glad that we managed to talk about this topic this year, as it is the 50th anniversery of the paper “the Relationship between Unemployment and the Rate of Change of Money Wages in the United Kingdom 1861-1957” written by our own Dr Phillips. In this paper Dr Phillips found that, over this period, there was a negative relationship between money wage changes and unemployment.

This was eventually broadened to a negative relationship between inflation and unemployement, which gave rise to the Phillips curve. Initially this led economists to believe that there is a trade-off between inflation and unemployment. However, the instability of the Phillips curve when policy analysts tried to take advantage of this relationship (when analysts tried to use the relationship it disappeared), and the popularity of the natural rate hypothesis (stating that there is a “natural rate” that unemployment settles at), led to a movement away from this, and the statement that there is no long-run trade-off between inflation and unemployment! (now viewed as the NAIRU)

Taking this as given, what other trade-offs are there? Read more

Matt Nolan

The cost of inflation

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Note: Other posts in this discussion are available under the tag “inflation debate“.

Hi again everyone. Apologises for the delay getting this out, I have been sick. I’m still feeling quite sick, so if you read anything you think is wrong be sure to comment on it – as it probably is.

Without too many substantive criticisms of our view of what inflation is (yet) it seems that we can move on with our discussion on “re-thinking monetary policy“.

The next step in this process is to ask, what are the costs of inflation?

Previously we defined inflation as:

when the price of all goods consistently increase for no “real” reason

Given this definition, we have to ask are there costs associated with a consistent increase in the general price level?

Read more

Matt Nolan

What is inflation?

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Note: Other posts in this discussion are available under the tag “inflation debate“.

Thank you for all the insightful and intelligent comments (and posts on other blog) on the Re-thinking monetary policy post. Now that you guys have put down the important issues that we have to look at with monetary policy all I need to do is discuss them with my own opinions 😉

However, even with all your help we can’t just jump straight in to saying whether policy should change or stay the same. First we have to define what the hell we are talking about! This involves starting with the question, what is inflation? Once we know what inflation is, we can figure out what the costs of inflation are. From there we can work out what trade-off exists when dealing with inflation, and then we can sort out whether current monetary policy is dealing with this trade-off appropriately.

There is a simple answer to what is inflation, but it isn’t particularly useful. The simple definition is that inflation is “the rate of change” in the general price level (*). To really understand what inflation is though, we have to understand what causes growth in the general level of prices.

Here I will go over some points that build off each other (the fundamental points are in italics, the bold bits are just titles 🙂 ). If you disagree with a specific point, raise your criticisms and we will discuss it and try to figure out where to go from there. Hopefully painting it out this way will make the final description transparent.

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Matt Nolan

Re-thinking interest rate policy: Asking for submissions.

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Note: Other posts in this discussion are available under the tag “inflation debate“.

So Trevor Mallard is suggesting that New Zealand “re-thinks” its interest rate policy.

Now his statements that the currency is a “one-way bet” is thinking that is associated with the NZX, while his statement that higher interest rates may have caused the housing bubble is the thinking of Berl – they both stem from submissions to a monetary policy review by the Parliament’s Finance and Expenditure Committee.

In fact, at the time I wrote about both of them, here for NZX and here for Berl. Overall, I felt that both of these organisations were completely wrong – which is why I’m so troubled that the current government has decided to follow their ideas.

Now given that I have discussed this business before I would like you guys to leave some comments saying what you think about the monetary policy framework and how you think it could be improved. I will then write some posts discussing the issues raised. Hopefully some people actually comment to this post :p . Please please please, write what you think 🙂

Note: I am not going to comment on this post, although I will be reading all the comments and thinking about them. Furthermore, and other blog members may comment. Feel free to say whatever stuff you feel about inflation and policy on it, and I will try to pull it all together later on.

Links to other posts discussing this issue can be found under the flap:
Read more

Matt Nolan

The Economist’s Inflation expectations primer

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The Economist has an excellent piece on inflation expectations (*) (ht Anti-dismal and the Economist blog). In it they mention some of the difficulties of using the inflation expectation measures as a gauge of inflation, namely:

  1. The problem with survey measures: Consumer often mis-interpret inflation, and take increases in the price of certain goods (eg fuel and food) as inflation – ignoring the reduction in the price of other things (appliances).
  2. The problem with market measures: Perceived risk also drives the same measures – implying that there can be biases.

Now I agree in large parts with what they have said, however I think they “over-sold” the first case. Read more

Matt Nolan

Are New Zealand’s inflationary pressures contained: The nominal wage evidence

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Greg Mankiw has an interesting post on what would make a good inflation target (ht CPW). According to work by Ricardo Reis and himself, aiming at the nominal wage is a good way of ensuring the highest degree of price stability – according to models calibrated to recent US data (paper here *).

Using this conclusion he shows a graph of private hourly compensation growth and states that inflationary pressures in the US are not as much of a threat as some analysts are positing.

If the same implication held in New Zealand (which there is no assurance of), how would we be looking:

Source, QES wage data Statistics New Zealand (*)

Not so good it seems 😛