Where is inflation? This is the question floated by the media based on US consumer price statistics, which show that the Federal Reserve's trillions of dollars in money injection and near-zero interest rates have not triggered the feared inflation. Some media put it as "the dog that did not bark".
As core inflation has remained at the magical 1% for the past decade, media pundits have suggested that the Fed could step its quantitative easing until core inflation exceeds the target of 2.5% per year. In fact, the question of "where is inflation?" is similar to looking for an object among an infinity of objects.
Austrian economist Ludwig von Mises pointed out that there are millions of goods and services in the economy which are
exchanged for money, out of which one can make millions of different price indices; each interest group chooses the inflation indicator that best fits its cause.
If a policy maker wants to boast price stability, then he cites core inflation, which excludes core food and energy products; this has been maintained at 1% per year in the past decade; if one wants to trigger inflation alarm, then one may cite housing and stock price inflation, which have been at a two-digit annual rate of 20% since early 2012.
Very low core inflation at around 1% per year did not prevent the financial collapse of 2008 and the drawn out economic recession that followed. Similarly, very low consumer price inflation in 1926-29 did not prevent the 1929 crash and the ensuing Great Depression. In 1929 as well as in 2008, asset price inflation was lethal and flared up in the context of very low consumer price inflation.
Some actions are basically wrong and one should not wait for disaster to happen to renounce them. For instance, smoking two packs of cigarettes per day is not recommended; one should not wait for cancer to spread to reduce smoking. Likewise addiction to drugs is not recommended; one should not force higher doses until brain damage occurs. Massive money printing is basically wrong, creates inflationary pressure, and is conducive to economic disorders.
Many economists have dismissed inflation as an indicator for prudent money policy. The so-called textbook Taylor rule (a guideline for interest rate manipulation) has long been repudiated by many economists including late professor and Nobel Prize winner Milton Friedman. Very low inflation is not an indicator of banking stability nor is very high inflation an indicator of bank fragility. Panics and bank runs may hit one bank and spread to the whole banking system in the context of very low inflation or even deflation.
The failure of the banking system causes loss of wealth to depositors, loss of financial capital, and therefore economic dislocation. In some countries, inflation may be very high because of monetization of large fiscal by the central bank; however, the private banking remains very safe because the interest rate and credit structure is not corrupted by distorted central bank policies.
The late Professor Charles Kindleberger described episodes of high asset price inflation and stable or declining wholesale and consumer prices indices in the US for 1927-1929, Japan 1985-89, and Sweden 1985-89. He noted that central banks failed to intervene to arrest asset price inflation, essentially for two reasons: central banks never undermine a stock market boom, and they are concerned only with consumer price inflation.
He pointed out that the consequences of asset price inflation were financial crises and economic turmoil. He wrote, "When speculation threatens substantial rises in asset prices, with possible collapse in asset markets later and harm to the financial system, monetary authorities confront a dilemma calling for judgment, not cookbook rules of the game."
When we address the question "where is inflation?" as "the dog which did not bark", we are bewildered by the traditional controversy about inflation, its measurement, and its political objective. As Mises pointed out in many of his writings, there are millions of prices and consequently millions of price indices; each price index will serve the cause a party stands for. Moreover, there are many definitions of money aggregates; each aggregate affects differently inflation.
We should note that the quantity theory of money is a long-run relationship, that holds tightly over a long period, between money aggregates and general levels of prices. It is an empirical fact that "inflation dogs" do not bark instantaneously when thieves sneak into the property; some dogs bark after some delay - with the thieves already leaving or having departed with the spoils; others may bark with an even longer delay.
While consumer price inflation measurement was less controversial in the '60s and '70s and led to price controls under the Richard Nixon administration, this concept was stripped and limited to core inflation; moreover, the notion of substitution has been introduced among groups of products. For instance, if the price of leather shoes increases then the statistician assumes consumers will buy plastic shoes whose price has dropped. Apprehending price increases may be elusive; for instance, bus fares remain the same; however, passengers are no longer issued transfer passes for other bus lines. In this case, is the price increase zero percent or is it 100%?
Undeniably, the question of where is inflation depends on which inflation one is looking for and the time span for measuring it. If one considers airfares cross the Atlantic, then prices have risen by more than 100% since 2011. If one is interested in the same airfares during the past three months, then the rate of increase is very small.
Likewise, if one is interested in crude oil prices since early 2009, then the overall increase is 133%; if one is interested in the rate of increase of crude oil prices for the past year, then it is 16%. Similarly, if one is interested in the price of soybeans since early 2009, then it is 72%; for the past year, it is 9.3%. For corn, the overall price increase since 2009 is 66%, and 9% for the past year.
If we omit groupings and use money, which buys every product and service, as a measure of inflation, then the rate of growth of US M1 money supply has been 12% in the past year.
Where is growth? The answer is totally disappointing. Trillions of dollars in new money and near-zero interest rates combined with trillions of dollars in fiscal deficits failed to bring about economic growth. Average real growth in the US during 2009-2012 was 0.8% per year; in the euro-zone a negative 0.4% per year; and in Japan 0.15% per year.
The spectacular stock market boom underway is fueled purely by the Fed's massive money printing and has no connect to the real economy; the average return on stocks at about 20% a year is pure redistribution of wealth as it far exceeds the real return of the economy at about 0.8% a year.
The dismal growth performance shows the deep inefficiencies of the Fed's policies. A simple truth is growth and employment need real capital; Fed's money printing and near-zero interest rates have not made real capital more abundant. Will the fall in real per capita income be reversed through more of the Fed's money creation? This is what is promised by the Fed. Money creation is a panacea to all diseases and is the path to economic prosperity, says the US Federal Reserve. So then must be looting and counterfeiting.
A central banker can be as arrogant as they come and as obstinate as an ass. The Fed will keep printing trillions of dollars and forcing near-zero interest rates till the end of the world. The question of "where is inflation?" will have the usual answer: there is none.
Undeclared inflation will encourage borrowers to step up their borrowing. Borrowers are favored by near-zero interest rates, high true inflation, and by defaulting as usual on monumental loans. It is a free for all: grab as much as you can. As has become fully admitted, the Fed will buy all failing loans. It is wealth redistribution via the Fed's money printing.
Noureddine Krichene is an economist with a PhD from UCLA.