Sunday, October 27, 2013

"Inflation", Nominal Income and the "Crowding Out" Effect

...Interesting to see Ken Rogoff (Binyamin Appelbaum, NYT) coming out in favor of more money printing. But, the way he goes about it serves up the usual dose of monetary policy confusion for all concerned, unfortunately. More inflation needed! As opposed to...what? In response, Marcus Nunes reminds us that inflation targeting only leaves the Fed vulnerable to more supply shocks, and Scott Sumner mostly wants to pull his hair out: "6% inflation is a horrible idea. If we had targeted NGDP growth at 5% over the past 4 years we'd be out of recession by now". In spite of some stats and numbers proclaiming we've somehow "arrived", many feel as though we haven't gotten anywhere yet and small wonder, for we haven't even used the right map.

When we think about the Fed "holding" down (i.e. capping) inflation as a desirable target, all one really gets is an overall surface effect, like looking at the ocean from a distance with no clue what it holds. Inflation targeting in all reality was never a good tool to use. Plus it became utterly useless, once services became relatively more important than tradable good production in developed economies. That in turn made employment potential more of a "mystery" than it ever should have been. For instance, excess emphasis on income levels were a part of the same problem, with the money illusion of surface observations.

In a sense, one could even argue that inflation targeting proved more useful to obscure actual income to consumption relationships than anything else. The same mechanism which made it easy to add excessive finance structures to asset creation, also made their availability easy to subtract at will. Of course, economic destabilization was inevitable whenever the latter happened. Unfortunately, the whole process tended to leave other assets - and capital - hostage to finance activities in ways which scarcely made sense to the average observer.

This strategy - if what the Fed "bumbled" into with inflation targeting could be thought of as such a thing - also made it easier to incorporate government relationships into the economy. Such integration might be beneficial in some contexts, but unfortunately the workings of finance (overreliance on credit use) is not among them. What's more, inflation of the sixties and seventies became problematic in large part because of the growth of finance, as building and construction elements began to contribute heavily to wealth redistribution in services.

Once reliance on finance became linked with governments and non tradable service settings, the crowding out effect against what had been more effective production residuals in the aggregate, slowly became more pronounced over time. Unfortunately, the reliance on inflation targeting also served to obscure the imbalances in marketplace conditions. What might employment possibilities look like today, had nominal spending had been stabilized with a level target all along?

For instance, consider production's so called "race to the bottom" in some quality respects, a common complaint amongst progressives. How much of that devolution in quality (to the degree it felt or seemed real) was brought on by market crowding? Already, there were existing demands on the pocketbooks of all income levels from rigid, non tradable product definitions. Crowding out effects from tight (sticky) markets, made it more difficult for many tradable good operations to compete on sustainable terms - for themselves and their employees. Disinflation of the desirable sort never even had a chance. It's too easy to blame oil for a lack of disinflation overall, for no one has to even think twice what could have happened instead (sorry, snark intended).

I looked at an example of both price and wage deflation over time in yesterday's post, for tradable goods in a retail environment. Still, the disinflation one would expect to see from these kinds of examples, is more than counterbalanced by the relative inflation which exists in non tradable services employment and asset structures. Lowered price levels in tradable goods competition, can also mean less left over for employee benefits and services expectations on the part of consumers.

In part because of the years I spent in retail and related services (both as an employee and self employed), and also non profit employment, those combined experiences make it difficult for me to take some concepts of employment and inflation at face value - thus the "oddball" claims in this post. Employment compensation processes just work in very different ways, depending on whether the employment takes place in tradable or non tradable product environments.

With non tradable services employment compensation - one doesn't always have the production residuals which suggest an appropriate or sustainable amount, given other existing variables in monetary flows. Because there may be fewer binding constraints (especially short term), increased valuations in local wealth designations may appear to have little or possibly no downside, especially for a community which is already successful. And the greater the valuations in non tradable asset holdings overall (by whatever means), the greater the compensation possible for non tradable services.

Binyamin Appelbaum  (linked above) inadvertently captured a part of the crowding out dynamic perfectly, in the last part of his article. In the process of negotiating wages with a low inflation environment, an Anchorage school board froze wages - rather than cutting them - for a number of years. Whereas Caterpillar attempted to freeze wages in a similar negotiation setting, but ended up letting almost half of their workers go, instead. While these are but two stories, plenty of variations exist on this theme, and they are heard quite often. More often than not, it is the tradable good production activity which is lost, when money is not immediately available to make it happen.

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