|
Some
time in the last decade—it’s hard to pinpoint exactly
when—central bankers started talking about inflation
expectations as if they had a life of their own.
No
longer were expectations just an accessory to the
inflation process, the gasoline on the fire. They were
endowed with a new independence and ability to actually
cause inflation.
This has
always been a problematic concept for me. The public’s
expectations of inflation may stray from reality for a
while, but ultimately reality intrudes to re-anchor
them, if you will.
Take the
hypothetical case of a central bank running a tight
monetary policy but talking publicly about pumping up
the economy, perhaps as a result of political pressure.
(Such things don’t happen nowadays, so just pretend for
argument’s sake.) The public, acting rationally on an
anticipated loss of purchasing power, would spend more
today.
How far
would those expectations go without ratification by the
central bank? Probably as far as Costco, where, after
purchasing a year’s supply of canned corn, our consumer
would find himself shelling out money for storage space
even as canned-corn prices were unchanged for months on
end.
Or take
the reverse situation, where a central bank is running
an easy monetary policy because the economy is weak and
the financial system is in distress. (Any similarity to
actual events is purely coincidental.) The central
bank’s benchmark rate is well below the current
inflation rate, a combustible situation because it’s an
invitation to borrow today, invest in something that’s
going up in price and pay back the loan in devalued
dollars.
Get me
rewrite!
Unable
to raise rates because of a fragile economy,
policymakers have to resort to jawboning.
It’s not
that they’re insincere about resisting “an erosion of
longer-term inflation expectations,” as Federal Reserve
chairman Ben Bernanke said last week. It’s just that
they would prefer not to have to do it now, especially
when they expect inflation to recede as demand weakens.
And
those expectations, if proven wrong, will eventually
converge with reality.
In a
speech last July to a group of academics on inflation
expectations, Bernanke explained relative price changes
versus a change in the price level (inflation).
“A
one-off change in energy prices can translate into
persistent inflation only if it leads to higher expected
inflation and a consequent ‘wage-price spiral,”’ he
said.
Shrinking people power
It
sounds as if inflation expectations are some kind of
Frankenstein monster. I’d rewrite the statement to read:
A one-off change in energy prices can translate into
persistent inflation only if the central bank
accommodates it, providing enough money to allow
consumers to spend more on energy without cutting back
on something else.
Soaring
commodity prices are sparking fears of the dreaded
1970s-type wage-price spiral. That’s when workers,
realizing their paychecks aren’t keeping up with rising
prices, demand a higher wage.
It was
one thing when labor unions had some bargaining power.
At the start of the 1970s, almost 30 percent of the US
work force belonged to a union.
Last
year union membership accounted for 12 percent of the
work force, according to the Bureau of Labor tatistics.
The rate for public-sector workers (35 percent) was
almost five times that of private industry (7.5
percent).
In order
for inflation expectations to produce a wage-price
spiral in the US, it would require powerful labor unions
and brain-dead businesses.
Rational
yet uninformed
“If it’s
something we have control over, expectations matter a
lot,” said Jim Glassman, senior US economist at JPMorgan
Chase & Co. “But I have no control over what wage I’m
going to get. Without a way to put those expectations
into practice, they can’t be self-fulfilling in a
competitive economy.”
I may
think I deserve a juicy salary increase this year—I
always do, whether I expect inflation to rise or
fall—but my employer doesn’t always see it that way.
(“Baum, try not to let the door hit you on the way
out.”)
In the
current environment, with businesses laying off workers,
“people are in no position to demand higher wages,” said
Paul Kasriel, chief economist at Northern Trust Corp. in
Chicago.
Ever
since Robert Lucas applied rational-expectations theory
to macroeconomics in the 1970s—something for which he
won the Nobel Prize in economics in 1995—econometric
modelers started to “assume people are rational, which
they are, and look forward, which they do,” Glassman
said. “But something’s missing.”
Expectations constrained
One
something is the lack of perfect information. An
informal inflation survey I conducted on the streets of
New York City last year showed that inflation
expectations, not to mention inflation reality, were all
over the map.
The
other something is a recognition of the “limits of what
people can respond to in their own lives in a
competitive market structure,” Glassman said. “It’s a
step too far to assume we can act on our expectations
and affect reality.”
For that
reason, it might be better if the discussion of
inflation expectations “stayed in the classroom, not in
policy circles,” he said.
How
about bringing it down another notch for folks like me?
The classroom is fine, as long as it’s in elementary
school, not a graduate economics department. |
