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Forecast 2: Stagnant Inflation and Investment, featuring Hyman Minsky and Jeffrey Sachs

January 23, 2011

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Today on the podcast, the Demand Side Forecast moves into inflation and investment, with able assistance from Hyman Minsky. We also take a listen to Jeffrey Sachs on economics, policy and governing.


Jeffrey Sachs, speaking to the Economist. More of Sachs remarks at the end of today’s podcast.

Now, Inflation and Investment. Forecast: Stagnation in both. Not surprising, because the two are connected.

Inflation used to mean a general rise in prices, and that is the primary focus of our analysis. This is easily confused with a rise in the CPI or other measures, which may be caused by specific, not general prices (often oil prices). Currently there is a rise in many commodity prices that is not part of any general surge in inflation, but stems directly from the financial markets. As we’ve said, it is parallel to the experience of late 2007 and the first half of 2008, when a commodity bubble blew up from a similar rush from speculators. Such events are not unprecedented by any means. Directly after World War II, one of the greatest so-called inflationary shocks occurred when American farmers were favored by the destruction of Europe and the release of pent-up demand from years of wartime restrictions. Food commodities began to be held back, speculating on continuing rises in price. Price controls had been turned off with the advent of peace. Why would you sell today, when by holding the grain your silo for a month, you could get ten percent more next month.

We cherry pick this episode, because the Truman Administration under the able direction of Leon Keyserling successfully deflected and resisted calls for restrictions on monetary policy. Truman essentially refused to shut down the economy to shut down the inflation. A short, sharp recession occurred as general demand was choked back by this commodity price extraction, but the economy righted itself and food prices broke and all just in time to help Truman come back against all odds in the 1948 election.

We’re getting a bit off track here, but there are a couple of other things to note about this post-war inflation. First, it took guts to hold the line on the reactionary call for economic slowdown. A similar inflation after the First World War had led directly into a serious recession. The nation only too well remembered the Depression years which had been, it seemed, only interrupted by the War and would now likely return, particularly considering the tremendous federal debt. But Keynesian and New Deal economics had brought the best minds of the generation to economics, and thanks to the political will of Harry Truman, they proved out.

Second, the monetary policy was still in control of the elected government at that time. So the president had the option of not turning up the interest rate. That is not the case today. In 1951 with the so-called Treasury Accord, the Fed won its independence as the fourth branch of government. What would they do in a similar situation? It has not been difficult to see. Most famously, during the oil price shock and subsequent price rise of the late 1970s, Paul Volcker executed the Monetarist experiment. Following the notion of Milton Friedman, Volcker restricted the supply of money. But instead of prices normalizing quickly and painlessly, as Friedman promised, interest rates shot through the roof and the recession of 1980 and then a much deeper recession in 1981-82 followed. The money supply was soon abandoned as a policy lever, to be replaced by the interest rate. But later, for example in 1999, when oil prices began to rise off their $15 a barrel floor, Alan Greenspan tightened the monetary screws against inflation — an inflation invisible to nearly everyone else — and precipitated the bust.

Well, that was a little bit out of the way. Back to the point and to Hyman Minsky. To say that Hyman Minsky anticipated the Great Financial Crash and the experience since 2007 is both accurate and not. Accurate because his analysis of the importance of financing structures and banks precisely described the causes and conditions and outcomes we have seen. “Not” because Minsky did not believe debt-deflation would occur in the era of Big Government. In the same sequence of elegant algebra we are about to visit for its relevance to inflation, Minsky demonstrated that profits are equal to investment plus government deficits. In a downturn, he said, quote

“In effect, Big Government rigs the economic game, so that profits are sustained; by sustaining profits, government deficits can prevent the burden of business debt from increasing during a recession.”

In this process, however, inflation was to be expected. Quoting again,

“Inflation may be the price we pay for depression-proofing our economy.”

Such inflation had the advantage of reducing the real value of debts and allowing the economy to escape its burdens.

Unfortunately, we have expanded private debt to a level unprecedented in human history and probably unanticipated by Minsky. At the same time we have eschewed the more aggressive Keynesian remedies in favor of holding the big banks harmless.

Moving quickly,

Inflation, in our general sense, needs to be seen primarily as a function of investment. Returning to Minsky’s algebra, and eventually we’ll get that up on the website — Demandsideeconomics dot net,

With the not too radical assumption that workers consume all their income, we can show that if all workers produce is consumption goods, then there is no inflation, because their income is matched perfectly by the supply of consumption goods. If some workers, however, produce investment goods, then the quantity of consumption goods is being bid on by both those who produce them and those who do not, hence the price goes up, mitigated only be any rise in productivity of workers.

That is the ultra short form.

Of course, the economy is not composed only of workers producing consumption or capital goods. There is a whole stratum of nonproductive labor in management, marketing, and so on. There is government. And there are resources, such as oil and mineral commodities whose price may be run up not by demand or utility in the real economy, but by financial speculation.

That this financial event will be confused as a real economy event is almost a foregone conclusion. So as we forecast no inflation, no investment, and stagnation, we also forecast continued buffoonery in policy, as the Fed and inflation hawks first scream about the commodity bubble and then, probably successfully, choke off recovery if or when investment begins again.

That’s the Demand Side forecast on inflation and investment.

Does Jeff Sachs have anything more uplifting. Let’s see.


That’s Jeffrey Sachs

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