Inflation Targeting

[Traktion]

I've posted this on a couple of threads now, but I haven't had a reply. Can targeting any positive number be sustainable in the long run, if:

- 'Inflation is always and everywhere a monetary phenomenon'

- The only lever we have is the price of credit (the interest rate)

Whether it is 2% or 10%, sooner or later, borrowers will be tapped out. This isn't about whether inflation is above/below growth, going hyper/deflating or whatever - I am merely pointing out that borrowing more, indefinitely, to hit a positive inflation target is, in itself, flawed.

So, by my reckoning to make the system sustainable you either have to:

1. Print more as you go along, to hit the target, rather than rely on borrowing ever more.

2. Target 0% inflation, accepting that inflation will have periods of being both positive and negative in equal (EDIT: or not - externalities etc) proportions.

I prefer the sound of 2, and if there wasn't a huge debt built up, I see little reason why there would be a deflation spiral - with little leverage, there is little to de-lever.

I find it hard to believe that the above wasn't considered, when they cooked up the idea of inflation targeting. Can anyone point out if/why I'm wrong, as the above seems pretty clear to me. Maybe I am missing something?

Edited June 20, 2010 by Traktion

[lowrentyieldmakessense(honest!)]

Maybe I am missing something?

its all just a con - it was never designed to work

the Rothbard analogy comes to mind - Central Banks shout look thief

[Traktion]

its all just a con - it was never designed to work

the Rothbard analogy comes to mind - Central Banks shout look thief

Surely, I must be missing something though, as it would be short sighted to say the least. Encouraging more borrowing, just to meet an inflation target was always going to end badly. It makes no sense.

[aa3]

You've got a really good point. When you put it that way it seems eventually borrowers would be tapped out. The bankers are very resistant to the idea of printing, because they don't make a profit on printed money.. unlike when they create the money and charge interest on it.

There are really strong reasons to target 2% instead of 0% economically. It puts a slight pressure on the money to go out into circulation, instead of being hoarded, which creates employment and opportunity for people to make money themselves. Because in our society money serves a dual role as a store of money and a medium of exchange.

[OnlyMe]

Inflation Targeting - just a smokescreen for monetary fraud and grace/favour status of bankers to feed off the economy.

They have gone too far this time and killed/offshored/outpricecd the golden goose and know they are in trouble.

[cashinmattress]

Define inflation.

What about hedonic adjustment.

Include capital movers such as property.

Define inflation again.

[Injin]

Define inflation.

What about hedonic adjustment.

Include capital movers such as property.

Define inflation again.

Inflation - money supply.

Basically the bank of england (in charge of the money supply) either can't do the basic math required to increase something by 2% or is doing it badly on purpose to rip us off.

Thieves or incompetents?

You decide!

[OnlyMe]

Inflation - money supply.

Basically the bank of england (in charge of the money supply) either can't do the basic math required to increase something by 2% or is doing it badly on purpose to rip us off.

Thieves or incompetents?

You decide!

Thieves, 100%.

[lowrentyieldmakessense(honest!)]

Inflation - money supply.

Basically the bank of england (in charge of the money supply) either can't do the basic math required to increase something by 2% or is doing it badly on purpose to rip us off.

Thieves or incompetents?

You decide!

the puppets do a good job at looking incompetent

[lowrentyieldmakessense(honest!)]

Surely, I must be missing something though, as it would be short sighted to say the least. Encouraging more borrowing, just to meet an inflation target was always going to end badly. It makes no sense.

it makes sense if you know the rules and can make money out of the con

but yes it was always doomed to failure and eventually being found out

[Traktion]

Define inflation.

What about hedonic adjustment.

Include capital movers such as property.

Define inflation again.

'Inflation is always and everywhere a monetary phenomenon', according to Milton Friedman. I would agree too. Credit money has certainly had an inflationary effect on prices, so observation confirms this too. Regardless as to whether you think broad or narrow money is the most important measurement, is debatable, but it's beside the central point.

Even according to Mervyn King of the BoE, broad money is a better indicator of prices, than the price indexes (such as CPI), but the latter are said to show change more quickly.

While you may get changes in demand, fluctuations in currency (which, in itself, could be an effect rather than a cause), over a reasonable period of time it would be safe to say that the money supply is the main driver. Given this, if you have a policy not to print, credit expansion will only continue for so long before hitting the limits - no matter how cheap borrowing is, you have to be able to pay back the principle in the end.

Edited June 20, 2010 by Traktion

[Traktion]

You've got a really good point. When you put it that way it seems eventually borrowers would be tapped out. The bankers are very resistant to the idea of printing, because they don't make a profit on printed money.. unlike when they create the money and charge interest on it.

There are really strong reasons to target 2% instead of 0% economically. It puts a slight pressure on the money to go out into circulation, instead of being hoarded, which creates employment and opportunity for people to make money themselves. Because in our society money serves a dual role as a store of money and a medium of exchange.

I understand the academic argument for keeping money moving, but if there are good investments to make, people will want to make them. I refuse to believe that people will just hoard money*, when there is more to be made by lending it to others. Why the need for constant stick, when there is always a carrot anyway?

* With FRB, it isn't like the money just sits in the bank anyway - it's loaned out to others, whether we like it or not. In addition, if you still think more is needed to prevent hoarding, why not just be honest about it and tax hoarders, rather than hiding it through inflation?

[Traktion]

Inflation - money supply.

Basically the bank of england (in charge of the money supply) either can't do the basic math required to increase something by 2% or is doing it badly on purpose to rip us off.

Thieves or incompetents?

You decide!

Given that Gordon Brown asked for CPI to be targeted at 2%, I can only assume the bankers mislead him into thinking it was a good idea or he had an agenda to collude with the bankers. Was he incompetent or a thief to be?

TBH, I was kind of hoping that someone would have a rational answer to my OP. Why haven't our economic experts been all over this since it was suggested?

[Injin]

Given that Gordon Brown asked for CPI to be targeted at 2%, I can only assume the bankers mislead him into thinking it was a good idea or he had an agenda to collude with the bankers. Was he incompetent or a thief to be?

TBH, I was kind of hoping that someone would have a rational answer to my OP. Why haven't our economic experts been all over this since it was suggested?

Because they are all either paid off or ******wits.

[scottbeard]

Inflation - money supply.

Basically the bank of england (in charge of the money supply) either can't do the basic math required to increase something by 2% or is doing it badly on purpose to rip us off.

Thieves or incompetents?

You decide!

Exactly, MV = PT

If you want P to rise 2% a year, set interest rate so that M increases 2% a year

Job done

[aa3]

I understand the academic argument for keeping money moving, but if there are good investments to make, people will want to make them. I refuse to believe that people will just hoard money*, when there is more to be made by lending it to others. Why the need for constant stick, when there is always a carrot anyway?

* With FRB, it isn't like the money just sits in the bank anyway - it's loaned out to others, whether we like it or not. In addition, if you still think more is needed to prevent hoarding, why not just be honest about it and tax hoarders, rather than hiding it through inflation?

A tax could work too, but I think the inflation is being honest if everyone knows ahead of time that the central bank is targetting 2%. It is official stated policy to target 2%.

There are other reasons to have a slight inflation as well. One is that we can't with 100% accuracy guestimate what the real inflation rate is. For example for decades in the figures there is assumed a 1.5% annual qualitative improvement in all products. But in some areas that is clearly a huge underestimate, for example in computing. Every 18 months or so the performance/price is doubling. Otoh does a doubling of performance equal a 100% qualit improvement for end users. Its hard to even define, let alone accurately measure.

And because deflation is so disastrous, it is better to build in a little bit of margin of error. It is one reason I support moving the inflation target up to 3% or possibly even 4%.

Yet another reason is human psychology. People will accept a 1% pay rise in a 3% inflation year AND be happy about it. But they will not accept a 2% pay cut in a 0% inflation year. Even though in real terms they are the same. Over time this allows small mistakes to be worked out without disputes.

[Traktion]

Is this a post really about the unsustainabilty of exponentially rising metics in general?

I could answer that the money supply needs to keep in step with gdp (and price inflation so says the BoE on their website) or there will be a shortage of money. gdp is rising at a compound annual rate.

So then you might say 'exponentially rising gdp is not sustainable'.

And I might answer but the population is growing by a compound annual rate each year.

And you might say 'but that is not sustainable'.

And you might be right. And all I would point out is:

1. In an exponential plot, we are always at the 'hockey stick phase' so don't be frightened by that.

2. Whilst you might be concerned about debts rising exponentially - have you ever considered how frightening it is to think that people are earning money at a compound annual rate on their deposits and a yield on other forms of wealth which are the mirror image of rising debts and the method of increasing the money supply?

3. Whilst on paper it is frightening, it can last an awfully long time, so I wouldn't plan your life around the inevitability of a collapse of the monetary system simply because of the compound growth of the money supply. I think you will see the signs of collapse well in advance of the problems becoming apparent.

It's not the exponential increase which worries me, it's the fact that it's borrowed. If it was printed, you could reach the same target, but without the upper bound of borrowing capacity to worry about - we can't collectively, borrow indefinitely.

1. Sure, it is the doubling time that is probably more interesting. At 2%, it's about 35 years.

2. It's an interesting thought, but I'm not sure if it changes the original premise (which is just concerned with increasing the money supply). By setting an inflation target, which requires an increase in the money supply to reach, only achievable by borrowing (as printing is against the Maarstricht Treaty), then there will come a point of 'debt saturation'. Maybe we hit this at the credit crunch, with 10x salaries and such, borrowed against houses (and then MEWed into the money supply)? Clearly, houses were ramping up quicker than 2% per year, which is probably why we hit a wall more quickly.

3. My premise isn't one of total financial collapse, but rather the inevitability of credit crunches. If your only lever as a central bank is to encourage more or less borrowing, while being unable to change the narrow money supply, then sooner or later there will be no more borrowing capacity to draw from.

Oh - I forgot to add that rpi itself is exponential - it decreases the value of debts exponentially. So you can play around with interest rates and inflation to manage the value of debts up or down. (clearly wages are another matter and historically they have tended to increase exponentially too).

While I understand and can digest your point, aren't we always vectoring in on a day when debts become suffocating? As interest rates have been tending towards zero for the last few decades, it would seem to suggest this. I've seen this illustrated on graphs where additional borrowing completely inhibits growth, so there would seem to be some sort of drag caused by ever more borrowing.

Returning to your initial point, saying that there 'isn't enough money' is really saying that money will appreciate as GDP rises, causing price deflation. In a low debt economy (ie. nothing like ours), I would have thought this would be relatively benign - you would plan to expect it and factor it into your interest burden; with 0% inflation, instead of 2% inflation, a loan with 5% interest would be equivalent to a 7% loan with the latter.

Regardless, if we want to keep an inflation target above zero, why not add to the money supply in a way which doesn't require more debt? Obviously private borrowing levels muddy the waters, but adding a small amount of narrow money into the economy each year/month/day (whatever is best) could dilute the money supply as required.

[lowrentyieldmakessense(honest!)]

Exactly, MV = PT

If you want P to rise 2% a year, set interest rate so that M increases 2% a year

Job done

how do you control V

[Traktion]

A tax could work too, but I think the inflation is being honest if everyone knows ahead of time that the central bank is targetting 2%. It is official stated policy to target 2%.

There are other reasons to have a slight inflation as well. One is that we can't with 100% accuracy guestimate what the real inflation rate is. For example for decades in the figures there is assumed a 1.5% annual qualitative improvement in all products. But in some areas that is clearly a huge underestimate, for example in computing. Every 18 months or so the performance/price is doubling. Otoh does a doubling of performance equal a 100% qualit improvement for end users. Its hard to even define, let alone accurately measure.

And because deflation is so disastrous, it is better to build in a little bit of margin of error. It is one reason I support moving the inflation target up to 3% or possibly even 4%.

Yet another reason is human psychology. People will accept a 1% pay rise in a 3% inflation year AND be happy about it. But they will not accept a 2% pay cut in a 0% inflation year. Even though in real terms they are the same. Over time this allows small mistakes to be worked out without disputes.

Taxation for redistribution would just be simpler, as you wouldn't be causing gyrations in the money supply, making long term planning easier. It would also mean you could leave the market to set interest rates. You could then just worry about addressing the hoarding issue in a conventional way - taxation to redistribute. Why have two competing mechanisms, which can contradict one another, when you can use just one?

Consider also, inflation targeting based on price indexes is subject to fluctuations in supply/demand of various goods. These could be external reasons (import costs change) or a change of habits (like people deciding buying houses isn't so good just now). Trying to price these things into a single, centrally managed interest rate, seems flawed to begin with. IIRC, the Austrian school simply concludes it is impossible to do this well.

I think people could quite easily expect no pay rise - in IT it's common. In bad times, everyone could take a hit, cut hours, redundancies and in good times they may get a pay rise. This is actually what has happened in this recession, so I refuse to believe it isn't possible. Even covering borrowing costs isn't any more of an issue, if 2% is trimmed from loan rates (i.e. no inflation compensated for) - the burden is surely just as large/small if pay is cut?

IMO, the problem is one of debt levels. Just a small amount of deflation can cause banks to become insolvent because they are so highly leveraged. I think this is the only real reason why deflation is undesirable, as it causes the house of debt cards to collapse; the system is brittle and it needs 0%+ inflation to function smoothly. The questions are: why do we have such a fragile system in the first place and why do we keep ratcheting up debt levels, making it ever more unstable?

Edited June 21, 2010 by Traktion

[Traktion]

Exactly, MV = PT

If you want P to rise 2% a year, set interest rate so that M increases 2% a year

Job done

I think you need to read the thread again. The point is whether borrowing more and more is sustainable, whether at 2% or otherwise.

[scepticus]

I agree that inflation targeting cannot work forever, or arguably, even for very long.

Because it only works when you can rely on the demand for borrowing outstripping saving demands.

The next phase, I would term it 'velocity targeting'.

In this phase, authorities aim to keep all existing money moving, with price levels being secondary (though not ignored).

However rising demand in the east (and appreciating currencies there - see the Forever Blowing Bubbles thread) seems likely to cause cost-push inflation on us that can't be solved with interest rate rise, which may make velocity targeting unnecessary, but still make inflation targeting impossible.

Stagflation, assuming capital flows go into reverse.

[Traktion]

The point here is that if some people are over indebted then there are others who have the wealth. There are different ways to bring the system back into balance.

Clearly, default is one. I don't think we should be any more frghtened of this as a solution than any of the others. Think of it as 'periodic debt forgiveness'.

Inflation is another.

Tax and incomes policies that make incomes more 'balanced' is of course yet another.

But doesn't a positive inflation target bring about the above by design? Without printing money, the only way you can increase the (broad) money supply is with ever more leverage, with ever smaller reserves held by the banks. How else could this positive inflation target (ie. increase in money supply) be achieved?

Yes, there are increasing imbalances (while broad money is growing) between those who have money and those who have debt, but I would say that is a separate problem (a big one too). However, I would say this is the direct result of trying to increase broad money (ie. leverage of narrow money), YoY, via an inflation target... sooner or later, the borrowing would have to stop (and indeed has).

Edited June 21, 2010 by Traktion

[Alan B'Stard MP]

What's the inflation rate if you drop your wallet down the drain?

[Alan B'Stard MP]

What's the inflation rate if you drop your wallet down the drain?

Sorry wrong thread. The tabs for mumsnet look very similar.

[Traktion]

What's the inflation rate if you drop your wallet down the drain?

Sorry wrong thread. The tabs for mumsnet look very similar.

Wtf?