Jump to content
House Price Crash Forum
Sign in to follow this  
hedgefunded

Simple Explanation Needed - Ir's Controlling Inflation

Recommended Posts

I might be being a bit thick here, but...

If inflation can be controlled by raising interest rates, thus reducing people's spending power, why isn't the current economic situation doing the same job?

In other words, why isn't inflation a self regulating mechanism? Prices can't go on rising at a greater rate than earnings, or evenutally nobody could buy anything.

As I see it, low rates =weak pound=expensive imports=less spending, and less spending is what's needed to bring down inflation isn't it?

I suspect I'm being a little naive, and I'm happy to be shot down in flames for an answer that explains the above.

Thanks

Share this post


Link to post
Share on other sites

Inflation with matching pay rises fuels further inflation. Without pay increases inflation is deflationary. More accurately it's bi flationary. In that the price of essential items fuel, energy, food increase while at the same time non essential discretionary items fall in value. Tvs, cars, houses etc. As people have to cut back to pay the increasing price of the essentials.

That's my take on it anyway.

Share this post


Link to post
Share on other sites

Interest rates are a mathematical equation con, you could arguable achieve the same with higher taxes.

High interest rates can also cause a malinvestment see what happened with Iceland high interest rates, capital flooded in and their banks went on a huge lending spree.

Inflation can exist for a variety of reasons, house price inflation was a result of malinvestment which created a self fulfilling prophecy where for a time prices only did go up because it kept attracting more and more people into the scheme.

Share this post


Link to post
Share on other sites

I might be being a bit thick here, but...

If inflation can be controlled by raising interest rates, thus reducing people's spending power, why isn't the current economic situation doing the same job?

In other words, why isn't inflation a self regulating mechanism? Prices can't go on rising at a greater rate than earnings, or evenutally nobody could buy anything.

As I see it, low rates =weak pound=expensive imports=less spending, and less spending is what's needed to bring down inflation isn't it?

I suspect I'm being a little naive, and I'm happy to be shot down in flames for an answer that explains the above.

Thanks

That's basically correct.

This is why economists are always going on about 'core' inflation. 'Core' inflation is supposed to be a measure of 'acutal demand' inflation. In other words, 'core' inflation strips out 'forced' spending and only measured 'discretionary' spending (it measures inflation in luxury goods, discretionary purchases, holidays, etc. and excluded essentials such as food, fuel, housing) . It is supposed to be a more useful measure of economic health as it measures the spending power of the population.

The fact is that 'core' inflation is much lower than the headline figure, if you look at the US where 'core' inflation is calculated officially - with 'core' inflation (until recently) close zero, with a several month period of sharp core deflation.

In the US, the Federal reserve have openly stated that they are targeting core inflation. The basic reason being that if rising resource prices are crippling an economy by withdrawing money from it, you don't want to withdraw even further money by raising IRs. Economic research based on periods of sudden resource/energy price spikes, suggests that it's better to live with 'externally forced' inflation (e.g. an oil shortage due to political unrest) rather than try to fight it. Attempting to target 'headline' inflation risks causing discretionary deflation, and damaging any subsequent recovery.

Share this post


Link to post
Share on other sites

Inflation with matching pay rises fuels further inflation. Without pay increases inflation is deflationary. More accurately it's bi flationary. In that the price of essential items fuel, energy, food increase while at the same time non essential discretionary items fall in value. Tvs, cars, houses etc. As people have to cut back to pay the increasing price of the essentials.

That's my take on it anyway.

...agreed...this is the adjustment prevailing...and will lower our standard of living which reflects our new found poor country status in the current world.... :o

Share this post


Link to post
Share on other sites

I might be being a bit thick here, but...

If inflation can be controlled by raising interest rates, thus reducing people's spending power, why isn't the current economic situation doing the same job?

In other words, why isn't inflation a self regulating mechanism? Prices can't go on rising at a greater rate than earnings, or evenutally nobody could buy anything.

As I see it, low rates =weak pound=expensive imports=less spending, and less spending is what's needed to bring down inflation isn't it?

I suspect I'm being a little naive, and I'm happy to be shot down in flames for an answer that explains the above.

Thanks

If I understand your question correctly, hoarding is your answer.

As real wages fall the profits of corporations and 'investing classes' go up. As consumption goods demand falls off, these profits are directed more and more towards means of production and commodities.

The hoarding of commodities caused in part by the devaluation of money (flight to tangible) and the constant injection of money that has to go somewhere generate what is misleadingly called 'cost push inflation': prices keep rising despite falls in demand.

<Edit to add: this is exactly what happened in Weimar. The entire population's (speculators excepted) wages were down to subsistence levels in 1923 but prices kept rising.>

Edited by _w_

Share this post


Link to post
Share on other sites

Inflation with matching pay rises fuels further inflation. Without pay increases inflation is deflationary. More accurately it's bi flationary. In that the price of essential items fuel, energy, food increase while at the same time non essential discretionary items fall in value. Tvs, cars, houses etc. As people have to cut back to pay the increasing price of the essentials.

That's my take on it anyway.

Well, obviously I'd agree with that, but I think there is more to biflation than just prices.

Biflation is also a monetary phenomenon. What we are seeing post crunch is less credit money being created (actually negative on some measures), whilst extra base money* was created in response.

*The wrong sort of base money as it turned out, but I'm sure they'll get it right next time.

Share this post


Link to post
Share on other sites

I might be being a bit thick here, but...

If inflation can be controlled by raising interest rates, thus reducing people's spending power, why isn't the current economic situation doing the same job?

In other words, why isn't inflation a self regulating mechanism? Prices can't go on rising at a greater rate than earnings, or evenutally nobody could buy anything.

As I see it, low rates =weak pound=expensive imports=less spending, and less spending is what's needed to bring down inflation isn't it?

I suspect I'm being a little naive, and I'm happy to be shot down in flames for an answer that explains the above.

Thanks

Interest rates affect the economy slowly. When the Fed changes the Fed Funds rate, it can take 12-18 months for the effect of the change to percolate throughout the entire economy. As rates increase, banks slowly lend less, and businesses slowly put off expansion. Similarly, consumers slowly realize they aren't as wealthy as they once were, and put off purchases.

Found the above which explains why higher interest rates curb inflation, basically because the slow the velocity of money, the rate at which people are spending. It also persuades people to hold onto money and keep it locked away earning interest.

However, your point is that people aren't spending so inflation should be lower. It is important to understand there are other forces at work in tandem though. Firstly, price inflation, while commonly known as inflation, is just a symptom of actual inflation, which is inflation on the money supply, which is what the BoE is happily getting on in the background via QE, which obviously puts upwards pressure on prices (dilute the purchasing power of money and prices go up). You also have to account for devaluation of the pound. As you point out this makes imports more expensive and as we are a net importer, this has a significant upwards effect on prices.

One other point that is little known about a weak currency is that it will make all products that we export more expensive for domestic customers too. How? If I am a farmer selling grain to the French and British and the pound falls 50%, I can put up the price of my grain 40% (the exact amount depends on competitors in the market) and the French will still be buying it cheaper than pre-devaluation and I'll be raking it in. As a domestic customer I now need to pay higher prices to the farmer to secure grain, because I am now competing with the purchasing power of French buyers.

So, while devaluation may be touted as boon for export industries, which it is, it doesn't help the cash strapped British Consumer one bit, unless they work in an export industry themselves.

Edited by General Congreve

Share this post


Link to post
Share on other sites

Interest rates have always been the 'transmission mechanism' for controlling the supply of credit money. They are a little confused because the transmission mechanism does not seem to be stimulating additional credit money despite hitting the zero bound. 'Pushing on a string'.

So the rate of increase in new credit has collapsed?

Even worse, unlike Japan who hit a similar problem, we actually have massive imported inflation because of the deliberately engineered destruction of the currency to 'rebalance the economy' and 'to make ourselves more competitive'.

(...)

Yup, how did they do that though?

Was it by appearing to inflate the base money supply?

(...)

the theory that lower demand will create deflation is pure fallacy.

No.

Less credit is deflation and creates price deflation in goods bought with credit.

Look at home improvements.

Share this post


Link to post
Share on other sites

I might be being a bit thick here, but...

If inflation can be controlled by raising interest rates, thus reducing people's spending power, why isn't the current economic situation doing the same job?

In other words, why isn't inflation a self regulating mechanism? Prices can't go on rising at a greater rate than earnings, or evenutally nobody could buy anything.

As I see it, low rates =weak pound=expensive imports=less spending, and less spending is what's needed to bring down inflation isn't it?

I suspect I'm being a little naive, and I'm happy to be shot down in flames for an answer that explains the above.

Thanks

Down to money supply, credit. Interest is a tax on it, nothing more.

This goes against the pillars of every major religion today.

Funny that.

Share this post


Link to post
Share on other sites

If I understand your question correctly, hoarding is your answer.

As real wages fall the profits of corporations and 'investing classes' go up. As consumption goods demand falls off, these profits are directed more and more towards means of production and commodities.

The hoarding of commodities caused in part by the devaluation of money (flight to tangible) and the constant injection of money that has to go somewhere generate what is misleadingly called 'cost push inflation': prices keep rising despite falls in demand.

<Edit to add: this is exactly what happened in Weimar. The entire population's (speculators excepted) wages were down to subsistence levels in 1923 but prices kept rising.>

This is an excellent post.

But what can one hoard these days?

Possession of paper promises of stuff is not hoarding, it's gambling.

You can hoard oil (if you happen to have it in ground you can control or a few hundred super tankers you can protect). You can hoard food (if you have the land to do so) for a year or two until it spoils and you can hoard fiat for as long as you want to, but excessive hoarding will tend to add to the supply, devaluing your hoard. Seems to me, all you can hoard is land and PMs, and specie isn't real money just now.

Edit: to remove idiocy.

Edited by Timm

Share this post


Link to post
Share on other sites

It helps if you see through the crap to what inflation really is. Price indexes are poor measures of anything meaningful, and in recent times have represented global trends - such as the rise of low-cost manufacturing in China - much more than our economy.

The inflation that matters is expansion of the broad money supply. M4 is a measure of the amount of credit (a.k.a. debt) in the economy, and if M4 grows faster than the real economy over a sustained period it's a credit bubble.

That's what happened with double-digit M4 growth for about five years leading up to the crash. That was serious inflation, but was masked in the CPI and RPI by ever more and ever-cheaper imports. That's the inflation that's now begun to feed through to prices, and has a long way to go. But because it actually happened several years ago, noone can stop it now without causing serious damage elsewhere.

If we'd used interest rates to target inflation 5-10 years ago when it was really happening, credit would've been more expensive, which would naturally have dampened the bubble and kept the economy from overheating. The cost would've been a little less growth (and a lot less HPI - since that was the biggest growth) back in the boom times.

2% as a target makes some sort of sense, in that 2% is a rate of economic growth we might aspire to sustain. But it fails miserably if the 2% targets such an irrelevant measure as CPI or RPI.

Share this post


Link to post
Share on other sites

The inflation that matters is expansion of the broad money supply. M4 is a measure of the amount of credit (a.k.a. debt) in the economy, and if M4 grows faster than the real economy over a sustained period it's a credit bubble.

You nail the point here. Posen is like someone who complains that he haven't got a pay rise for 3 years but forgot to mention that he

have had double digit productivity busting pay rises in the past 6 years or so...

If you look at Singapore's policy - they move their exchange rate up to curtail imported inflation - but of course they can do that

because they had been prudent and have lots of forex reserve to play the game.

Inflation is nearly always a monetary phenomena and the £150bn deficit is a bigger cause of inflation than the 0.5% rate..

Mr Buffet said a few years back - if government can run large deficit without consequences, government around the world would

have figured that out long ago...

Edited by easybetman

Share this post


Link to post
Share on other sites

Yes, I understand the economical definition of deflation thanks Timm. Less (credit) money chasing the same amount of goods should, so the standard theory goes, create deflation of prices.

But that is exactly my point - British industry's 'capability' (short sightedness/self preservation instinct, delete as appropriate) at managing capacity down rather than reducing prices and, in the case of devaluation, taking higher profits rather than expanding market share by reducing prices.

In the diy case you suggest, we have seen quite a lot of reduction in capacity already and we will see more. Whether it be by number of stores, number of staff, breadth of ranges, stock levels - whatever - that 'capacity' is being managed down effectively with the price reductions coming mainly through a reduction in quality, size etc. Which is not true deflation of prices imo.

If the company fails to bring goods to market at the market price, then they don't make enough sales to stay afloat.

IMHO, this is what has happened to Habitat - the market price has fallen below the lowest price they can sell at.

Edited by Timm

Share this post


Link to post
Share on other sites

If inflation can be controlled by raising interest rates, thus reducing people's spending power, why isn't the current economic situation doing the same job?

In other words, why isn't inflation a self regulating mechanism? Prices can't go on rising at a greater rate than earnings, or evenutally nobody could buy anything.

As I see it, low rates =weak pound=expensive imports=less spending, and less spending is what's needed to bring down inflation isn't it?

Try this explanation from Khan Academy

http://www.khanacademy.org/video/inflation--deflation---capacity-utilization?playlist=Current%20Economics

.

Just taking money out of the ecomomy will only lead to a change in velocity, all other things being equal. Economics makes more sense to me when it relates to how people will tend to behave with their own self interest in mind.

Share this post


Link to post
Share on other sites

And then today we have another 'expert' Martin Wolf telling us that

"In high-income countries inflation is reasonably under control."

http://www.ft.com/cms/s/0/28e2d3e2-a1b5-11e0-b9f9-00144feabdc0.html#axzz1QdsXKCdj

and then someday back US FOMC member was telling people that hedonically adjusted

IPad price has half and hence there is no inflation...

When we have people who do not 'live' in the real world dictating IR policies.. this is the sort of madness that we get...

Share this post


Link to post
Share on other sites

Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.

Guest
Reply to this topic...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...
Sign in to follow this  

  • Recently Browsing   0 members

    No registered users viewing this page.

  • 312 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



×
×
  • Create New...

Important Information

We have placed cookies on your device to help make this website better. You can adjust your cookie settings, otherwise we'll assume you're okay to continue.