David Glasner on Inflation and Recovery: 'We are in an expectational trap'


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At Uneasy Money, Federal Trade Commission economist David Glasner takes a look at the potential impact of inflation on relative prices and household spending.  And he provides this chart, "showing the average rate of change in the CPI and in the selected components from January 2008 to January 2010 along side the changes from January 2011 to January 2012."


There seems to be some inverse correlation between the rate of price increase in a component in the 2008-10 period and the price increase in 2011. Of the 6 components that increased by less than 1% per year in the 2008-10 period, four increased in 2011 by 4.7% or more in 2011, the remaining components increasing by 4.4% or less in 2011. So the rapid increases in some components in 2011 may simply reflect a reversion to a more normal pattern of relative prices.

I agree that inflation is not neutral. There are relative price effects; some prices adjust faster than others, but I don’t think we know enough about the process of price adjustment in the real world to be able to say that overall inflation in conditions of high unemployment amplifies relative distortions. What we do know is that even after a pickup in inflation in 2011, inflation expectations remain low (though somewhat higher than last summer) and real interest rates are negative or nearly negative at up to a 10-year time horizon. Negative real interest rates are an expectational phenomenon, reflecting the extremely pessimistic outlook of investors. Increasing future price-level expectations is one way – I think the best way — to improve the investment outlook for businesses. We are in an expectational trap, not a liquidity trap, and an increase in price-level expectations would generate a cycle of increased investment and output and income and entrepreneurial optimism that will be self-sustaining. Say’s Law in action; supply creates its own demand.

Read the full post here.

(h/t Mark Thoma)

Posted 02-27-2012 8:57 AM by Graham Griffith
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