One of the questions that often comes up in economic discussions is: why is a positive inflation rate seen as a good thing? There are a few angles to this question, which makes it somewhat more complex. I am somewhat ambivalent on the subject, but I believe the best answer lies in the area of political economy, not economic theory.…Bond Economics
Why Is A Positive Inflation Rate A Good Thing?Brian Romanchuk
One reason it's desirable is that having the wage for different skills vary with respect for each other in response to supply and demand is desirable, but as Keynes said "wages are sticky downwards", i.e. wages cannot be cut in heavily unionised sectors.
ReplyDeleteErgo the only way of adjusting relative wages, is to have the wage for some professions rise, while others stay static for a while. That tends to make some inflation inevitable.
I'm not sure that's a foolproof argument, but it's a point of sorts.
How to get rid of inflation and deflation
ReplyDeleteComment on Brian Romanchuk on ‘Why Is A Positive Inflation Rate A Good Thing?’
Brian Romanchuk takes the question “Why is inflation above 0% considered a good thing?” as a starting point for a psychological/sociological study of what different people/groups think how inflation/deflation affects them.
His answer is the usual vacuous It depends: “I could try to discuss the economic theory questions associated with price stability. My view is ambivalent.… As a result, I would argue that the economic theory is a red herring: what matters is political economy.”
Needless to stress that this is not the answer of a scientist: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)
Brian Romanchuk, though, is not a scientist but a blathering agenda-pusher. He has NO idea how the monetary economy works. Time to remind him of some economic basics and of some basics of scientific methodology as well.
As the correct analytical starting point, the elementary production-consumption economy is defined with this set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.
Under the conditions of market clearing X=O and budget balancing C=Yw in each period, the price is given by P=W/R (1). This is the most elementary form of the macroeconomic Law of Supply and Demand.
In the most elementary case, the price P is determined by the wage rate W, which takes the role of the nominal numéraire, and the productivity R. The quantity of money is NOT among the price determinants. This puts the commonplace Quantity Theory forever to rest.
In the elementary production-consumption economy, the price P performs a random walk which in turn depends on the random changes of productivity R and wage rate W. Note that the price movements do not depend on the random changes of employment or on whether the economy is at full employment or not. Equation (1) implies W/P=R, i.e. the real wage W/P is always equal to the productivity R.
Monetary profit for the economy as a whole is defined as Qm≡C−Yw and monetary saving as Sm≡Yw−C. It always holds Qm+Sm=0, or Qm=−Sm, in other words, the business sector’s surplus = profit equals the household sector’s deficit = dissaving. Vice versa, the business sector’s deficit = loss equals the household sector’s surplus = saving. This is the most elementary form of the macroeconomic Profit Law.#1 As long as C=Yw, macroeconomic profit is zero.
As a matter of principle, the elementary production-consumption economy is reproducible for an indefinite time. It is important to note that there is no such thing as an equilibrium or price stability or full employment.
Now it is easy to see that price stability, that is a rate of inflation/deflation of zero, can be established with a simple institutional rule: change of wage rate = change of productivity. In equation (1) this stabilizes the price P forever at the given level. No inflation, no deflation, no random price movements.
See part 2
Part 2
ReplyDeleteSo, if the Legitimate Sovereign decides to implement absolute price stability and asks the economist how to achieve this goal, the economist has a clear-cut answer. It reads W'=R' with ' indicating the rate of change. No wish-wash here, no ambiguity, no senseless blather.
Of course, things become more complex in the investment economy and when the price becomes the independent variable and employment becomes the dependent variable. These issues have been dealt with elsewhere.#2 The bottom line is that to set the inflation target at 2 percent is plain economic idiocy.
Egmont Kakarot-Handtke
#1 Truth by definition? The Profit Theory is axiomatically false for 200+ years
https://axecorg.blogspot.com/2018/07/truth-by-definition-profit-theory-is.html
#2 See cross-references Employment
http://axecorg.blogspot.com/2015/08/employmentphillips-curve-cross.html
Brian Romanchuk
ReplyDeleteYou say: “There is an extremely long line of academic arguments that suggest the determination of what is ‘good’ is a question of philosophy/ethics/religious belief.”
True, and this is why economists should stop blathering about philosophical, ethical, and religious issues. Science is about true/false and NOT about good/bad.#1 Economics has to define itself as a system science.
The elementary version of the correct (objective, systemic, behavior-free, macrofounded#2) Employment Law is shown on Wikimedia.#3
From this equation follows inter alia:
(i) An increase in the expenditure ratio rhoE leads to higher employment L (the Greek letter rho stands for ratio). An expenditure ratio rhoE greater than 1 indicates a budget deficit = credit expansion, a ratio rhoE less than 1 indicates credit contraction.
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase in the factor cost ratio rhoF=W/PR leads to higher employment.
The complete employment equation contains in addition profit distribution, the public sector, and foreign trade.
Items (i) and (ii) cover Keynes’ familiar arguments about aggregate demand. The factor cost ratio rhoF as defined in (iii) embodies the macroeconomic price mechanism. The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R.
Roughly speaking, the Legitimate Sovereign has two policy parameters: rhoE and rhoF. Now, rhoF, in turn, is composed of W/PR. It is pure dilettantism to set the rate of price increase at 2% without taking the other variables into consideration. What has to be set is NOT one isolated variable but the policy parameter rhoF as a whole. A smart policy to reduce unemployment and to eventually arrive at full employment would be to set P'=0 and W' >R' with ' indicating the rate of change. If, for example, P' is set at 2% and W'=R' unemployment INCREASES.
This brings us back to the initial question: “Why is inflation above 0% considered a good thing?”
The answer is because economics is a failed science and economists do not know how the monetary economy works. False theory leads to false policy guidance. With their defective employment theory, economists bear the intellectual responsibility for the social devastation of mass unemployment.#4 Therefore, it is NOT good for society to take these incompetent blatherers seriously.#5
Egmont Kakarot-Handtke
#1 Beware of the moralizing economist
http://axecorg.blogspot.com/2018/06/beware-of-moralizing-economist.html
#2 The macrofoundations approach starts with three systemic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X. For a start it holds X=O.
#3 Wikimedia, Employment Law
https://commons.wikimedia.org/wiki/File:AXEC62.png
#4 For details of the big picture see cross-references Employment
http://axecorg.blogspot.de/2015/08/employmentphillips-curve-cross.html
#5 As Napoleon said: don’t listen to economists
http://axecorg.blogspot.com/2016/04/as-napoleon-said-dont-listen-to.html