Dangerous Metaphors

A couple of days ago, I wrote post gently (I hope) chiding Olivier Blanchard for what seemed to me to be a muddled attempt to attribute inflation to conflicts between various interest groups (labor, capital, creditors, debtors) that the political system is unable, or unwilling, to resolve,leavin, those conflicts to be addressed, albeit implicitly, by the monetary authority. In those circumstances, groups seek to protect, or even advance their interests, by seeking prices increases for their goods or services, triggering a continuing cycle of price and wage increases, aka a wage-price spiral.

My criticism of Blanchard wasn’t that the distributional conflicts that worry him don’t exist — they obviously do — or are irrelevant — they clearly aren’t, but that focusing attention on those conflicts tells us very little about the mechanisms that generate inflation: the macroeconomic policies (monetary or fiscal) under the control of governments and central banks. We live in complex societies consisting of many diverse and independent, yett deeply interrelated and interdependent, agents. Macroeconomic polilcies are adopted and implemented in an economic and social environment shaped by the various, and possibly conflicting, interests of these agents, so it would be absurd to argue that the conflicts and tensions that inevitably arise between those agents do not influence, or even dictate, the policy choices of governments and monetary authorities responsible for adopting and implementing macroeconomic policies.

Because distributional conflicts are inherent in any economy composed of a diverse set of agents pursuing their own inconsistent self-interests, so it seems quixotic to suppose or even imagine that distributional conflicts can be resolved by a formal negotiating process in the way that Blanchard seems to be suggesting. There are too many interests at play, too many conflicts to reconcile, too many terms to negotiate, too many uncertain conditions and too many unforeseen events requiring previously reached agreements to be renegotiated for these deep-seated conflicts to be resolved by any conceivable negotiation process.

The point that I tried to make is that, because it is unrealistic to think that the fundamental conflicts of interest characteristic of any modern economy can be reconciled by negotiation, the monetary authority should aim to adopt a policy on which economic agents can rely on in forming their expectations about the future. The best policy that the monetary authority can hope to achieve is one that aims for total nominal spending and total nominal income to increase at a predictable rate consistent with an inflation rate low enough to be politically uncontroversial. If such a policy is implemented, with nominal spending and income increasing at roughly the target rate, private expectations would likely converge toward that targeted rate, thereby contributing to the mutual consistency of private expectaions that would allow inflation to remain at an acceptably low rate.

Brad Delong kindly noticed my comment about Blanchard on his substack blog and on Twitter, opining that Blanchard and I were not really disagreeing but were talking past each other.

I don’t necessarily disagree with Brad’s take, but I’m not sure that I agree either, because I’m not sure that I understand what Blanchard is actually saying. I actually tried to hint at my uncertainty about what Blanchard’s argument actually is (and whether I disagree with it) by borrowing (with slight modification) the lyric of George and Ira Gershwin’s standard “Let’s Call the Whole Thing Off.” (Or, try out this version.)

Paul Krugman also weighed in, defending Blanchard’s analysis against the argument which he attributes to John Cochrane and to me that inflation is always the result of excessive demand.

Although Blanchard is nobody’s idea of a leftist (OK, Republicans seem to consider anyone more liberal than Attila the Hun a Marxist, but still), he nonetheless got immediate pushback from economists who insisted that inflation is always the result of excessive demand, of too much money chasing too few goods or, what is roughly the same thing, the consequence of an excessively hot economy.

https://www.nytimes.com/2023/01/03/opinion/inflation-economy.html?searchResultPosition=1

I’m always grateful to be noticed by Krugman, but I’ll just note in passing that he’s not quite correct in attributing to me the view that inflation is always the consequence of an excessively hot economy; I was simply working with Blanchard’s own framing in his original Twitter thread.

But the point in Krugman’s post that I want to comment on is his football metaphor.

At one level, of course Blanchard is right. Companies that charge higher prices and workers who demand higher wages aren’t doing so because the money supply has increased; they’re trying to increase their incomes (or offset declines in their incomes caused by, say, rising energy prices). And inflation happens when the attempts of firms and workers to claim a bigger share of the economic pie are inconsistent, when the additional purchasing power being demanded exceeds what the economy can deliver.

Reading the discussion, I found myself remembering a remark made way back in the 1970s by William Nordhaus, another eminent economist (and Nobel laureate) who happens to have been my first mentor in the field. Nordhaus compared inflation to what happens in a football stadium when the action on the field is especially exciting. (If you don’t find American football exciting, think of it as a soccer match.) Everyone stands up to get a better view, but this is collectively self-defeating — your view doesn’t improve because the people in front of you are also standing, and you’re less comfortable besides.

Nordhaus’s football metaphor is very apt as far as it goes. You can imagine that inflation starts as the result of an attempt by agents to increase their prices (wages) that turns out to be self-defeating because everyone’s attempt to increase his price or wage relative to everyone else’s turns out to be self-defeating when everyone else does the same thing, so that no one really improves his position compared to everyone else.

I will just observe parenthetically that it is not strictly true that no one improves his view of the field, because people who are taller than average likely will improve their view of the field, especially if they are sitting behind short people. But that is likely a second-order effect. Similarly, some people raising their prices may be well-positioned to increase their prices more than average, so that they may be net gainers from the process. But again those are likely second-order effects.

But here is where the football metaphor breaks down. Blanchard is not worried about a once and for all increase in the price level, which is what the football metaphor translates into. People standing up in a football game do not keep growing taller once they stand up. The process comes to an end, and is eventually reversed after people sit down again.

But inflation is unpopular because it supposedly is a continuing process of increasing prices. Larry Summers and Blanchard have been invoking the experience of the 1970s in which there was supposedly a self-generating or self-reinforcing wage-price spiral that could only be stopped by a brutal monetary tightening administered by Paul Volcker causing a severe recession with double-digit unemployment. To avoid another such catastrophic recession, Blanchard is urging everyone to be reasonable and not to try to increase prices or wages in a likely futile attempt to gain at the expense of others.

The problem with football metaphor is that it can’t explain how the inflation process can continue if it is not enabled by macroeconomic policies that cause the rate of nominal spending and income to keep increasing. Maybe Blanchard and Krugman believe that total nominal spending and total nominal income can keep increasing even if macroeconomic policies aren’t causing nominal spending and nominal income to increase.

I don’t think that’s what they believe, but if they do believe that, then they should explain how continuing increases in nominal spending and income can be generated without corresponding macroeconomic policies that promote those increases in nominal spending and income. As long as macroeconomic policy is focused on keeping the rate of increase in nominal spending at a rate consistent with the target rate of inflation, inflation will be just as transitory as episodes of standing by fans at football games.

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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