It's time to talk about inflation again (*sigh*)
Shrinkflation & More
Let’s start with this article from NPR: What tracking one Walmart store's prices for years taught us about the economy
To me, what it teaches is exactly what we talked about a few months ago: inflation is not a uniform increase in prices, therefore talking about a single “inflation rate” is meaningless.
That's because we see prices increasing in all sorts of different ways. Some prices go up a lot; others less so, while some products remain the same price. A few products even go down in price. This is exactly what we saw before, but now we have empirical evidence to back it up. From the article:
So, a shopping basket at a Walmart in Georgia offers a view into the U.S. economy — and the inflation that has roiled it. It's a bit painful if you're shopping for aluminum foil or eggs. But not so bad if you want cabbage or Wonder bread. And you may even find a relative bargain on shrimp.
The article points out that some products remain the same price but come in smaller packages—known as "shrinkflation." This is a stealthy way of concealing increased prices to the consumer.
When looking for the reasons for price increases, the article lists the following reasons for the highest price spikes seen at the Wal-Mart store:
Supply-chain woes show up in many aisles. Wood and wood pulp for paper products were affected by big pandemic demand and the war in Ukraine. Severe droughts caused the worst oat harvest in North America in over a century. Avian flu ravaged egg-laying hens. Aluminum imports — for foil, cans and other products — have faced a roller coaster of tariffs...And what about the original reason for our visit to this Georgia Walmart: Did lingering impacts of Donald Trump's trade war with China add to price increases?
You'll note what's missing from the above description: "too much money printing". Instead, you'll see plenty of other reasons for inflation: Pandemic-related supply-chain disruptions. Droughts and poor harvests. Labor shortages. Trade wars and tariffs. Avian flu. War in Ukraine. Computer chip shortages. Fuel prices. And so on1.
Also, you would also have to explain why the money supply (as measured by M1 and M2) rose for over a decade prior to 2019 with no significant price increases2. Then, you would have to ignore the fact that price increases just so happened to coincide with major geopolitical events such as trade wars, pandemics, droughts, and energy cost spikes.
And, of course, some prices actually came down. For example, after an initial spike in demand which caused the price of electronics to soar, prices ended up coming back down again, just as one would expect:
Electronics were among the counter-inflationary highlights of last year, as supply-chain backlogs resolved and stores found themselves overstocked. In fact, televisions often tend to get cheaper every year, with the Vizio TV on our shopping list no exception.
Walmart also has stopped selling some items from big-name brands…in favor of private brands that are usually more profitable. This can give a store more wiggle room to lure shoppers with lower prices, while still making its money.
Plus, retailers have authority to set prices on individual items. Former Walmart pricing officials say either the company's buyer or a store manager could, for example, suppress a price increase on a popular item and choose instead to spread that cost hike across other products.
This may be part of the story for Procter & Gamble's Head & Shoulders shampoo that has kept its price steady since 2019 — or the Argo Corn Starch that's gotten cheaper. Argo's parent company, ACH, said the brand had not lowered the price. Walmart did not comment.
Note that the article also lists a factor that you rarely hear about: the fact that retailers also have significant power to set the prices of the items they sell.
So, ultimately, what does an overall "inflation rate" tell us? The answer is, "not much". Why are price increases so variable? The simplest and best explanation would that inflation is really just the market allocating resources. That is exactly what it is supposed to be doing. Yet in the modern understanding of markets promoted by economists, markets are only supposed to be magic wonderlands that do only good things, and when they do things we don't like, it must be some sort of government "interference." Hence the "too much money printing" trope, or the belief that the meager Covid relief checks are still causing inflation years later, despite the money having already been spent years ago.
Excuseflation
Recently, another cause for inflation has been added to the above: excessive profit taking by corporations.
The argument is that the widespread perception by consumers of an inflationary environment and higher input costs allows corporations to jack up their prices far in excess of what they normally would be able to using the inflationary environment as an excuse.
This belief was heightened by a series of conference calls between executives and investors that have since become public. In these calls, the executives openly admitted that they were raising prices simply because they could, and not solely because of increased costs. Providing additional supporting evidence is that fact that company after company has reported all time high profit margins despite high inflation and consumers tightening their belts. This trend has been dubbed "excuseflation". This post from Cory Doctorow explains the concept:
As Joseph Stiglitz and Regmi Ira wrote for the Roosevelt Institute last December, "Weak unions, globalization, and changes in the structure of the economy" mean that workers generally can't demand inflation-tracking wage increases...Stiglitz and Ira lay out five causes of inflation: energy and food spikes, changes in what we want, supply interruptions, higher rents – and price-gouging (notably, none of these can be fixed by jacking up the interest rate at the central bank).
As the Stiglitz/Ira list of five causes shows, it's not just price-fixing that causes prices to go up – but every one of these causes feeds into price-fixing, thanks to a phenomenon called excuseflation...Take Pepsi: after the Russian invasion of Ukraine, Pepsi pulled out of Russia. But its profits remained steady, because Pepsi was able to raise its prices in the rest of the world – blaming the war, of course...Why don't customers switch to Coke? It turns out that duopolies like Pepsi-Coke are able to tacitly collude on pricing, and Coke is also raking in massive profits.
Excuseflation (Pluralistic.net)
Doctorow's post is based in part on a recent podcast from Odd Lots, which explores the trend of companies raising prices even if it costs them market share. This is known as a Price over Volume (POV) strategy.
For some reason, much of the recent focus has been on rising egg prices. It's known that an outbreak of avian flu caused farmers to have to slaughter chickens, which caused egg prices to increase substantially. However, a closer look has found evidence that the rise in egg prices is far in excess of what would be expected from avian flu alone. And, sure enough, a handful of corporations control most of the egg distribution in America.
Monetary Fallacies
Blair Fix has been on a tear recently, writing a number of posts taking on the inflation orthodoxy. Fix's posts are a must-read. Consider supporting him if you can.
Perhaps the most hallowed tenet of this orthodoxy is the idea that raising interest rates brings down inflation. But is there any empirical proof of this?
When Fix sets out to examine whether there is, he finds a couple of things:
1.) Rather than high inflation being associated with an "overheating" economy and low inflation associated with a "stagnating" economy, it turns out that high inflation is associated with stagnation more often than not. In other words, "stagflation" is not exceptional but the normal state of affairs.
The Cause of Stagflation (Economics from the Top Down)
If you think about it, this makes sense. When prices go up, people tend to buy less. Buying less is associated with a shrinking economy. So, of course we would expect the economy to slow down in an environment of high and rising inflation. We saw this during the 1970s.
But in economic orthodoxy, inflation is caused exclusively by "too much money chasing too few goods." In this view, raising interests will bring down inflation because it will constrict the money supply, and hence the economy, causing it to stop “overheating” which will theoretically reduce inflation (with unemployment as an “unfortunate” side result). This may have made sense in the days when you walked around with silver coins in your pocket buying sundries from peddlers, but it's probably not an accurate description of how globalized, post-industrial economies using fiat currencies work. In fact, Fix also found that:
2.) Raising interest rates is associated with an increase in the money supply, not a decrease. This is as heretical belief as you can possibly have, since it is literally the opposite of what drives the policy response of governments around the world. Yet when Fix constructs a data set using World Bank data, he finds that there is no empirical basis for this idea:
The World Bank database is quite clear that triple-digit interest rates exist. For example, in 1992, Nicaragua had interest rates north of 450%. And in 1994, Ukraine experienced interest rates of about 250%. A year later, Angola had interest rates above 200%. (I could go on.) Of course, we can quibble with the measurements behind these numbers...But what seems clear is that interest rates can get absurdly high.
Now according to orthodoxy, these extreme interest rates should be money-supply killers. But if that were true, the trend in Figure 3 would slope downward (meaning higher interest rates slow the growth of the money supply.) However, the trend slopes upward. In other words, higher interest rates are associated with a faster expansion of the money supply.
Do High Interest Rates Reduce Inflation? A Test of Monetary Faith (Economics from the Top Down)
Why, then, is this the orthodoxy? It turns out that it was never based on any actual evidence but merely ideology, specifically the ideology of Milton Friedman. Friedman declared inflation to be "always and everywhere a monetary phenomenon." (and therefore, not related to any of the things we mentioned above) This became an article of faith among economists—a central tenet of belief akin to the Shahada for Muslims.
In this view, raising interest rates is effectively raising the price of money. In perfect supply and demand curves, if you increase the price of something, people will demand less of it. Therefore, raising interest rates will theoretically cause people to borrow less, decreasing the money supply and reining in inflation. In theory, anyway.
Unfortunately, just like most economic pseudoscience, this imaginary mental exercise does not apply to the real world. Fix cites a paper by Tim Di Muzio, who outlines the reasons why higher interest rates might actually cause the money supply to increase:
In his article ‘Do Interest Rate Hikes Worsen Inflation?’ Tim Di Muzio claims that there is good reason for monetary orthodoxy to be wrong. The problem boils down to the ceteris paribus clause — the assumption that when we raise interest rates, nothing else changes. To restate orthodox reasoning, if I have a fixed budget to spend on servicing my debt, then it follows that when interest rates rise, I’ll borrow less money. But what if my debt-servicing budget is not fixed? Then orthodoxy breaks down.
In the real world, Di Muzio observes, businesses don’t need to reduce borrowing in the face of higher interest rates. Why? Because when interest expenses increase, businesses can respond by trying to raise their income. In other words, businesses can maintain their debt levels by passing their greater debt-servicing costs along to customers.
Let’s lay out the consequences of this heretical thinking. If businesses practice ‘cost-plus’ pricing — meaning they tack a fixed markup onto their current costs — then raising interest rates ought to stimulate inflation. What’s frightening is that this simple reasoning is consistent with the monetary evidence...
Note that DiMuzio’s reasoning is entirely consistent with the real-world evidence presented in the Odd Lots podcast, above.
This also makes intuitive sense. If it costs more to service loans, there needs to be more money in the economy to pay the higher interest rates on those loans. That money has to come from somewhere, hence there will be more money sloshing around the economy, not less. The conclusion:
The take-home message is clear: when we look at the World Bank database, there is no evidence that higher interest rates down-regulate inflation. If anything, the evidence suggests that rate hikes make inflation worse.
Once again, if you want a shorter summary, Cory Doctorow has an excellent rundown: Higher interest rates increase both the monetary supply and inflation (Pluralistic.net)
Fix says that at best, monetary policy – raising interest rates – simply fails to mitigate inflation. But at worst, it actually increases inflation. Here he echoes Joseph Stiglitz and Regmi Ira, who compare interest rate hikes to bloodletting. If the patient gets worse, you're not bleeding them enough. If they get better, the bloodletting clearly saved them. If they die, well, some diseases are simply incurable."
In follow-up posts, Fix notes that this data sent orthodox economists into "war mode." This consisted of people invoking various economic "laws" and hurling personal insults, but not questioning or invalidating any of the actual data. The next post is a bit more challenging, but worth a read. Fix discovers that if you lag the data appropriately, you can make almost any correlation you wish to make, regardless of whether it is true or not. This was how the various economic “laws” and the supposed correlation between interest rates and inflation were established:
To summarize, we still have no evidence that interest rates down-regulate inflation. However, economist [sic] won’t be convinced until we torture the data with lags. I say ‘torture’ because when it comes to inflation, lagging the data can be dangerous. You see, interest rates and inflation are both highly cyclical — they rise and fall over regular intervals. Given these cycles, the danger is that if we lag the data ‘sufficiently’, we can invert the obvious correlation...Unfortunately, if we lag the data ‘sufficiently’, we can find (apparent) evidence for down-regulation...
The problem with this method should be self evident. When data is highly cyclical, we can always use lags to invert the obvious correlation. Here are some dubious examples. Want to ‘show’ that the sun cools the Earth? Take sunlight data and correlate it with temperature data 12 hours later. Want to ‘show’ that pressing your car’s brakes speeds up the vehicle? Lag the speed data by the duration of a stop light.
Interest Rates and Inflation: Knives Out (Economics from the Top Down)
Examining the information, Fix finds out that this is exactly how orthodox economists "prove" Friedman's theory. When more rigorous and consistent methods are applied, the correlation breaks down entirely.
Another trick economists use to bamboozle the public and justify their theories is invoking something called the "real" rate of interest. However, Fix shows that this "real" interest rate is just a result of autocorrelation, that is, correlating something with itself:
By construction, the ‘real’ interest rate is the actual interest rate minus the rate of inflation. If we compare this value back to the rate of inflation, we’re introducing autocorrelation. We’re correlating inflation with the negative version of itself:
inflation ∼ real interest rate
inflation ∼ interest rates − inflation
So with ‘real’ interest rates, we have a recipe for defining our theory to be true.
In a world in which actual interest rates have no relation to inflation rates, we can use autocorrelation to flip the conclusion. ‘Real’ interest rates appear to regulate inflation. Except that it’s just inflation that is correlating with the negative version of itself.
And that’s why I don’t play the ‘real’ interest game. You can’t define your causal variable in terms of the thing you’re trying to explain. In short, any theory that explains inflation in terms of ‘real’ interest rates is statistically illiterate.
Supposedly, the 1970s proved Friedman correct. But did it? Interest rates were raised for nearly a decade to punishingly high levels (as high as 18+ percent) with no effect on inflation and pushed the economy into a deep recession. Paul Volcker is still hailed as "hero" by many for putting millions of people out of work and permanently destroying the United States' manufacturing base. Yet inflation only really started coming down after energy prices started falling.
Similarly, the most recent inflation happened after a decade of money supply expansion, and started coming down once the economy opened up again and supply chain troubles eased, along with a reduction in energy prices.
Isn't this just the classic post hoc ergo propter hoc fallacy: “after this, therefore because of this?” After all, if you raise interest rates every time there is inflation, and inflation eventually comes down, you can you always claim that those two things are correlated. But is that really true? In fact, Fix examines this and—no surprise—finds that the interest rate "medicine" is once again contradicted by empirical evidence. In another satirical post, he shows how you can justify basically anything if you tweak the data sufficiently, including the idea that you can reduce inflation by higher wages:
The Key to Managing Inflation? Higher Wages (Economics from the Top Down)
Why, then, is this the economic orthodoxy? Fix compares it to a kind of religious belief or superstition. Similarly, as we saw above, Joseph Stiglitz compares it to the medieval remedy of "bleeding" the patient until he or she is better.
In reality, higher interest rates help bankers and creditors, because they gain more income from their loans. It also decreases worker's bargaining power by slowing down the economy, and hence their ability to command higher wages. This, Fix suggests, is the real reason behind these beliefs, and Friedmanite monetarism is merely an ideological fig leaf to justify policies which benefit the rich and powerful at the expense of everyone else—just like nearly all economic pseudoscience:
In scientific terms, the behavior makes no sense. But in ideological terms, it is easy to understand. By and large, mainstream economics exists to justify the behavior of the powerful. On that front, the idea that interest rates ‘reduce’ inflation is a convenient veneer for an otherwise self-serving behavior.
Faced with inflation, everyone tries to raise their income. But not everyone has an official ideology backing them up. Tellingly, when workers try to boost their wages, economists scream that it will make inflation worse. Yet when creditors do the same thing, economists pass it off as an act of altruism. ‘It just looks like a money grab,’ economists declare. ‘But it’s actually a noble medicine for everyone.’
All of this seems to confirm the idea that modern-day economists are no better than astrologers advising the kings of ancient Babylon based on the alignment of the stars and planets, or the soothsayers of ancient Rome who observed the behavior of flocks of birds and the livers of geese in order to advise the rulers on the proper course of action. I mean, it's literally the same thing! Economists are merely a priesthood dressed up in scientific drag. And yet this is the level of knowledge that is guiding all of our societies in the twenty-first century. Have we really advanced at all???
Fictitious Commodities
Finally, this chart lists the items that have come down in price compared to those which have gone up in price:
You’ll notice that necessities like housing, education and health care have all skyrocketed precipitously, anything with screens has become cheaper, while other durable goods have remained mostly the same until very recently.
What do all these things have in common? To reiterate what I have stated previously, they are all fictitious commodities. They are all things that markets are inherently unsuited to distribute properly.
Karl Polanyi—who originated the concept—focused on money, land, and labor as his fictitious commodities. I’ve previously argued that housing is not a commodity for various reasons. But I would also argue that education and health care are also fictitious commodites3, and those are the ones that are crushing the average American.
After all, education is a fundamental requirement to participate in certain professions. It’s controlled by a cartel, who set the price for entry into those professions, and that is even before the explosion of college degrees. They are effectively a drawbridge gatekeeping the middle class lifestyle. When the economy produced plenty of well-paying jobs that did not require degrees, there was less of an incentive to pay exorbitant prices for an education. Now that those jobs are gone, people have no other choice. I defy you to go on any college Web site and tell me exactly what the costs of that education will be upfront. Not to mention expensive education functions as a “signal” to potential employers for those able or willing to pay. Why on earth would we expect “free markets” to adequately distribute such a thing?
And health care is not something one goes out shopping for, despite the presence of advertisements for cancer care as if one were buying a new car or appliance. Nobody wants to undergo medical treatment unless they have to, and you undergo it until you get better. Nobody goes out shopping or compares prices for an ambulance ride or a visit to the ER. The application of market-based ideas to health care is the most insane thing I can possibly imagine.
So the commodification of these things may be the fundamental reason why their costs have become so decoupled from reality. It’s the application of “free market” principles to absolutely everything—even to things where they don’t belong. Until and unless we can get past free market fundamentalism as the central guiding principle of our society, I don’t see be any hope for those things to ever become affordable again.
See this thread for some interesting anecdotes: Eli5: how have supply chains not recovered over the last two years? (Reddit)
One sample:
“I can tell you what’s going on in my industry, aerospace manufacturing.”
"Our material suppliers went through significant layoffs in 2020. They lost many skilled laborers to retirement and simply being laid off. Now that demand is back they can’t get the skill back that is needed to produce conforming product. They are hiring unskilled people and having extreme quality issues."
"Lead time prior to the pandemic was 3-5 weeks for material. Lead time now is 48-52 weeks. It’s a beyond huge problem for aerospace because this particular material is spec’d into a lot of parts and there is no alternative to it."
And:
“In addition to the logistics issues that have been mentioned, which impacted the ability to produce and transport goods around the world, there is also the "toilet paper effect": which is the desire of people who were burned by shortages to attempt to stock up on years' worth of components critical to their own products. e.g. imagine that your entire car production line was stopped because you couldn't get a $1 LED. When things started moving again you'd probably order several years worth of those LEDs right? When everyone does that and hoards what they can find there is a shortage that continues even when the supply has returned to normal levels.”
I've actually seen someone trying to argue that the previous ‘money printing’ acted as 'tinder' piling up in the metaphorical underbrush, which was set off by the 'spark' of pandemic spending. Libertarians will come up with absolutely anything to justify their received belief system, even while claiming a monopoly on ‘reason’.
And for some reason, both of them have seen an incomprehensible explosion in administrative bloat—people who push papers rather than doing any actual work. I don’t think that’s a coincidence.
Well done, Sir. I'm adding this edition to the other two on housing costs, and will be referencing all of them in my next episode.
—Perry
Re: inflation. Over the past 25 years there's been a clear convergence around the world towards "orthodox" monetary/economic policies of fiscal discipline and inflation targeting by independent central banks, and the countries which have pursued this most aggressively are definitely more stable, economically, than the ones which did less of it. Latin America today vs. the 1980s is an excellent example. The orthodoxy isn't always right, but neither is it catastrophically wrong. After all, unemployment is currently at historic lows across much of the planet.
Inflation is only partly mechanical and has large psychological inputs. When Jerome Powell says that he's determined to fight inflation at any cost and is raising interest rates to do so, the mechanical effect of higher rates is only part of the story. The other and probably more important part is the signaling aspect, wherein holders of dollars keep believing that inflation will stay low, that government money creation won't get out of control, and that other players won't succumb to inflationary psychology. The psychological aspect as well as the influence of uncontrollable 'transitory' factors like supply chain disruptions, etc. are all pretty well-understood by the orthodoxy, which is why the Fed waited so long to start hiking rates; they started to fear that temporary influences were giving way to a more generalized inflationary psychology.
The thing is that governments (politicians) *always* want to spend more printed or borrowed money, and they're always tempted to pursue short-term (before the next election) gain irrespective of long-term pain, so to be any use at all the economics profession needs to be conservative and systematically lean against this to a certain extent.