Inflation in the Twenty-First Century: Unintended Consequences

Kevin Coldiron is a lecturer in the Masters of Financial Engineering Program at the Haas School of B
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  1. Thank you Kevin.
    The most concise and clearly written explaination of the current problem facing central banks and investors I have read to date.
    Looking forward to your follow up.

  2. Avatar for KCP KCP says:

    I’m staying tuned - looking forward to the next segment w/ great anticipation!


  3. I really like the note, like others have said it is clear and concise about a topic that lends itself to completely different adjectives. Which is always great.

    But, (and given the credentials of the man writing this and , really, everyone here on this forum…I am starting to doubt myself a little), how can there be a 21st century diagram of the opposing inflationary/deflationary forces on either end of the “unstable equilibrium”, that does not list “technology/innovation” as a source of deflation? Does this not firmly belong alongside globalisation and demographics?

    And if not, is the argument being made that technological innovation at this point in history has no (!) impact on inflation or simply that the inherent difficulties in measuring the direct impact of this disqualifies it from the diagram?

    I understand that it complicates the picture that technology does not advance on a linear scale, that progress tends to happen in a step-change manner which means that there will be periods in time where there is very little impact on inflation one way or another - but this diagram is supposed to reflect 1980 to 2021! Are we saying that technological innovation during this period has had no bearing on inflation?!

    The Federal Reserves itself, which perhaps for obvious reasons, has not paid too much attention to the disrupting tendencies of technological innovation started to organise a conference series in 2019 and even the description of the conference succinctly summaries the disinflationary impact of technology:

    Technology-enabled disruption means that workers are increasingly being replaced by technology. It also means that existing business models are being supplanted by new models, often
    technology-enabled, that bring more efficiency to the sale or distribution of goods and
    services. As part of this phenomenon, consumers are increasingly able to use technology
    to shop for goods and services at lower prices with greater convenience—which has the
    impact of reducing the pricing power of businesses. This reduced pricing power, in turn,
    causes businesses to further intensify their focus on creating greater operational
    efficiencies. These trends appear to be accelerating.

    I am genuinely puzzled by this. It feels like anyone would need a solid reason to completely leave it out of a diagram attempting to portray the opposing forces at play and measurement bias is in my opinion that reason enough.

    What I am missing? :thinking:

  4. Avatar for 010101 010101 says:

    Hi Em, Friedman said something like “inflation is always and everywhere a monetary phenomenon”. In the idealist monetarist controlled economy, prices are stabilised by policy. The implication is that the equilibrium is an administrative choice.

  5. Yes, I am aware of Friedman’s quote. And of course, as a monetary economist he would prefer to define inflation as a purely monetary phenomenon. In the strictest sense, I will even agree that in the sense that inflation is defined as prices going up - then yes it is a monetary phenomenon.

    But in the diagram in the article we are talking about, other distinctly non-monetary phenomenons are referenced, under the heading of “Structural”. “Demographics” is not a monetary phenomenon after all., so technological innovation would in my opinion belong under this heading in order to accurately reflect the pull and push between monetary and structural forces.

    The equilibrium may well be an administrative choice, to me the interesting question is whether the administration process is accurately taking into consideration all relevant structural forces, if technological innovation is not considered.

  6. There is absolutely no doubt about that being true. Harvesting technology is only one of so many examples - crop biotechnology, pesticide/herbicide development, advances in processing/freezing/preserving/packing technologies, cold chain infrastructure that reduces spoilage and preserves food product integrity, etc,

  7. Which is partially why I find it strange to have a conversation about whether or not inflation will come down or go up from where we are today, without bringing technology into the equation.

    Maybe the answer is that it will not (at least not in this decade) change anything, but can we (or should we?) have the discussion without including it?

  8. The impact of technology on productivity, including technologies impacting the utilization of agricultural and marine resources to produce various products including food products for humans and animals, ingredients for food products, or health and beauty aid/personal care products, etc. is constant, but may be more perceptible to casual observers when it happens in bursts. But it is always present and active, i.e, there is never a time when technology/innovation isn’t contributing to productivity gains, therefore counteracting price inflation (or bearing a deflationary effect).

    However, I think that including the effect of technological advancements in the discussion about price inflation would confound the issue more than elucidate. This view hinges on the belief that the most valuable technology/innovation would occur whether or not the efforts to develop it are supported by government spending, and that pure capitalist motives are sufficient to spur the financial and operational investments needed for technology to advance. It’s therefore a view that’s difficult to maintain and defend amid so much evidence that taxation policy, and fiscal/trade policy do have a considerable effect on R&D investment.

    Imo, this is an inextricably complicated problem specifically because of the level of wealth and power concentration we have in the world today and the ability of that concentrated power to impact all forms of policy (fiscal, monetary, trade, taxation, you name it) makes it almost hopeless to believe that policies will focus on boosting real economic growth through productivity gains, as opposed to being guided by corruption and things that are essentially legal fraud. The worst part about this is that the poorest and most vulnerable are very often the strongest supporters of policies and systems that deprive them of opportunities and/or work against their current interests because they are naive enough to believe the stories they are told by the establishment.

    All that to say: if we include technology and government spending in the discussion about causing inflation to go up or down, then we should include the reality that these are influenced by a captured set of institutions, legislative and governance frameworks. Denying the latter part would be disingenuous toward the discussion topic, imo.

    Edit: I think Friedman’s position probably assumed that governments and regulators always become captured and corrupted, and I think it’s impossible realistically to deny that this has occurred in our modern society, and this should be factored into any discussion that looks for non-monetary elements affecting inflation, particularly if those are often supported by government spending.

  9. Thanks James, I very much appreciate that.

  10. This is a very good point. My plan was to write 4 inflationary posts, this is the 2nd one. The third one was about the deficit and the global flow of dollars and the fourth was going to address your point - could technology lead to productivity gains and thus growth without inflation. This post is just out, and is based on an interview I did with Mark Mills who wrote The Cloud Revolution. He is VERY optimistic - expecting big gains in healthcare productivity from the convergence of new developments in AI, computing and materials. I don’t know enough to properly critique his reasoning, but I hope he’s correct.

  11. Your points are well taken Siff, just note that all the pesticide & herbicide applications farmers have used over the decades (starting after WW1) has harmed the soil over the long term. Greater applications of the “cides” (poisons) have to be delivered to the soil which kills the billions of beneficial bacteria and microbes that naturally exist in soil.
    Greater amounts of fertilizer also have to be applied to maintain the same food production, suffocating our waterways over the long term.
    Nutrition content per plant has declined over the decades.

    It is quite possible that just as climate change may force the world to use less efficient sources of energy (see Inflationary) , our long term soil and water degradation may force farmers to use less of the poisons to produce food in the quantities we’re used to (see Inflationary)

  12. Avatar for KCP KCP says:

    Stupid me…just read a substack article on disconnect b/w Bidenomics view of their accomplishments and the view from the feet on the street. (thanks to whoever in ET forum turned me on to Stoller in Substack)

    I did not know that interest rates are not part of the CPI calculation.

    With record consumer debt, that interest bill is great for Visa/MC/Synchrony and banks but wow that increased interest cost has to be an opportunity cost to something else in a household. And in the corporate world, an increased cost through the supply chain.

    Amazing that the Fed didn’t encompass rising interest rates in their “Stress” tests until SVB/FRB failures. And the CPI publisher (not sure who is actually tasked with defining CPI) doesn’t include interest rates which are sadly having an ever encroaching meaning in our lives - for those on the street and even those in the clouds…

    I learn something new every day.

  13. BLS:

    There’s plenty of controversy regarding their methodology (e.g., Owner-Equivalent Rent, hedonic adjustments, how they capture insurance, etc.), but I’m not sure there’s any way to squeeze interest rates into a measure of changes in the price level of an economy.

    I’m not saying that higher interest rates doesn’t impact people’s spending habits, I just don’t see how it could be considered inflationary. Taken at face value, the rising interest rates and QT (Fed policies) are meant to curtail aggregate demand in the economy (deflationary).

    I couldn’t agree more!

  14. Avatar for 010101 010101 says:

    Higher interest rates decrease volume of consumption. Decreased volumes of consumption reduce sales volumes. Reduced sales volumes decrease producers’ gross revenue and capital spending, Reduced capital spending reduces production (as production capital is needed to maintain levels of production). Reduced production increases price levels per unit of sales because demand for consumption is a constant consumer choice constrained by access to liquidity and time preference.

  15. This is what I meant by “deflationary”. Powell is ostensibly trying to force a reduction in demand across the economy in order to bring the inflation rate down.

    That happens via lower investment spending and lower consumer demand as you mention (reduced capital spending and decreased volume of consumption.)

    Perhaps this will eventually lead to increased price levels per unit of sales, but the damage will have been done.

    I’m not sure how to reconcile this:

    [quote=“james stewart, post:16, topic:2871, username:010101”]
    demand for consumption is a constant consumer choice constrained by access to liquidity and time preference. [/quote]

    with your first sentence.

    EDIT: Sorry for the formatting, can’t see why it won’t just quote you.

  16. Avatar for 010101 010101 says:

    Decreased consumption is not because the consumers want to consume less. The demand for consumption is not the same as the aggregate demand for m1, m2 and m3 in the economic system. It is because the purchasing public are constrained by less access to credit liquidity and their previous lack of savings habits.
    The consumer demand will express through the ballot box if it isn’t satisfied with consumer credit spending.

  17. Plus (and I would argue primarily due to) income constraints.

    Link (to underlying data for that chart): Growing inequalities, reflecting growing employer power, have generated a productivity–pay gap since 1979: Productivity has grown 3.5 times as much as pay for the typical worker | Economic Policy Institute.

  18. Avatar for 010101 010101 says:

    The productivity/wages ratio is an unavoidable result of the tendency of capital spending to look for these efficiencies. It does create a finer balancing point between commercial sector employee total numbers and output volumes.
    What do you think will be the first thing to be shrunk as consumption volumes reduce and access to liquidity (credit risk) follows?

  19. I’m not exactly sure this is answering your question, but one big thing that has been on the downtrend for at least the past 7-8 years is buying a car.

    You may recall the post dotcom bust when Greenspan induced a housing bubble to help boost the economy. Before the housing bubble really got going, the low interest rates spurred dealers to offer zero-percent financing and that kept sales flowing until the financial crisis:

    It took 6-7 years to get back after the financial crisis, but this chart is not population adjusted. Teenagers and young adults are much more likely to rule out car ownership since the mid-2010’s (my observation, pure anecdotal data though I have a frontline view.)

    Just my opinion, but I think Americans will continue to assess their personal financial realities and I would expect lower household formation, less children per capita and further reduction in car ownership to drive a big chunk of that drop in demand.

  20. Avatar for 010101 010101 says:

    The difference between the monetarist definition of aggregate demand and the human meaning of demand is clear. The upcoming generation might want to form a household but are too poor to be able to demand it. If they had access to the credit risk they would buy cars also. Human demand is a social phenomenon. Monetary demand (not demand for spending money) is a policy choice.

  21. Back to the heading - 10yr UST yield closed 4.36% having touched 4.41% yesterday

  22. Ben predicted that interest rates face an asymmetric risk of becoming “unmoored”. The price action post-Fed, with the Treasury yield curve breaking above key technical levels that marked the highs for this cycle last Fall, is a key first step. The yield uptick continues in the face of the stubborn consensus that inflation will fall in the period ahead, with the resulting crowded postioning in long duration.

    Found this to add from BofA’s Fund Manager survey in September.


  23. Yep agree - suddenly we are at 4.5%…

  24. Avatar for 010101 010101 says:

    Just to be clear; is the chart a survey of managers of global funds or a global survey of FMs?

  25. I’ve never stopped to consider which! It is just BofA’s survey of their clients that has been produced monthly for years. I’d refer you to the source to find that detail.

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