Economics

The Price Paradox

Feb 25, 2015 Robert Skidelsky

Apostles of monetary expansion continue to believe that avoiding deflation is simply a matter of speeding up the printing press. But why should this be any more successful in the future than it has been in the last few years?

LONDON – In 1923, John Maynard Keynes addressed a fundamental economic question that remains valid today. “[I]nflation is unjust and deflation is inexpedient," he wrote. “Of the two perhaps deflation is…the worse; because it is worse…to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other."

The logic of the argument seems irrefutable. Because many contracts are “sticky" (that is, not easily revised) in monetary terms, inflation and deflation would both inflict damage on the economy. Rising prices reduce the value of savings and pensions, while falling prices reduce profit expectations, encourage hoarding, and increase the real burden of debt.

Keynes's dictum has become the ruling wisdom of monetary policy (one of his few to survive). Governments, according to the conventional wisdom, should aim for stable prices, with a slight bias toward inflation to stimulate the “animal spirits" of businessmen and shoppers.

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Robert Skidelsky

Writing for PS since 2003
208 Commentaries

Robert Skidelsky, a member of the British House of Lords and Professor Emeritus of Political Economy at Warwick University, was a non-executive director of the private Russian oil company PJSC Russneft from 2016 to 2021. The author of a three-volume biography of John Maynard Keynes, he began his political career in the Labour party, became the Conservative Party’s spokesman for Treasury affairs in the House of Lords, and was eventually forced out of the Conservative Party for his opposition to NATO’s intervention in Kosovo in 1999.

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Flórián Mézes Mar 1, 2015

well
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Barry McHugh Feb 25, 2015

I also crunched the numbers for guys about our age who will have about 20 years to live from now (give or take, and it rolls forward at 20 years as you keep living). PLUS SIDE: Assume about an 8% return from your balanced investment fund (2 year avg. returns on the better Australian funds are doing that (ignoring currency depreciation of Australian dollar)). Take off tax and inflation and your left with a real return of 4% but that's before risk!!!. RISK: Plenty of that * Greece, *Brazil, *$9 Trillion more debt post GFC, *China Local Government debt Ponzi (land as collateral for loans then using money from land sales to service debt), and all of it not too dissimilar to the pre-Japan stock market crash when brokers guaranteed against loss. Now Japan's Nikkei and the Yen/CHF cross rate at their worst was a minus 90% for investors ex-Switzerland and all those countries 'tied' to its currency. Defray the 90% over 20 years, (i.e. assume a crash hitting your investment fund equivalent to that at sometime in next 20 years) and your potential 'risk hit' to your return is minus 4.5% (net -ve 0.5%). TO CUT A LONG STORY SHORT, OLDER GUYS NEED A 45% MARKET CRASH BEFORE WE CAN BE VERY COMFORTABLE WITH PUTTING OUR MONEY ANYWHERE NEAR STOCKS. Otherwise, we're just fooling ourselves, and the rest of the copy we see in the economic press is just spin to us. Sorry.
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Paul Daley Feb 25, 2015

Skidelsky is right that monetary policy has been relatively impotent in moving prices. He might have added that it has been equally impotent in producing growth or full employment. But that was not because policy was overpowered by outside forces, it was simply poorly implemented with inappropriate tools.

Monetary policy initiatives are invariably felt first and foremost in capital markets through the impact of real interest rates on the price of existing assets. This is particularly true of QE initiatives. But what impact can higher prices for existing assets have on the demand for new goods and services. In the long run, there may be some wealth effects, but in the short run those existing assets compete with new goods and services for funds. That is the problem. Capital markets have now grown so large that little of the impetus provided by monetary initiatives escapes to the real economy. That is why monetary policy is so feeble. In econ-speak, it has a transmission problem.

What to do? There are lots of possibilities but the simplest, cleanest and most effective would be just to expand central banks' tool boxes so that capital gains tax rates and real interest rates were inextricably tied together through some inverse function. Then changes in capital gains tax rates would offset changes in real interest rates. Together they would stabilize capital values and permit any monetary stimulus to pass directly to the real economy.

Is any of this likely to happen quickly? A few more years of slow growth, growing inequality and recurring financial crises may be enough to convince central bankers that their current efforts are doing more harm than good.
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Jose araujo Feb 25, 2015

One of the problems of helicopter views is that sometimes we miss out something very important.

According to the current view of models, we are living in an era of low interest rates, zero and even negative interest rates, but is it true?

If we go to a bank and ask for a loan, what interest will be charged?

First they will try not to lend you money, second the interest will not be low or zero.

So, we are not living in an era of ZLB interest rates, we are living in a an era with zero risk free interest rates and huge risk premia.

Can monetary policy change the risk premia? Conventional monetary policy can't, but unconventional policies can, how ?

Examples os measures that would improve the situation:

Setting up public mortgages banks.
Buying comercial paper
Tightning regulation and supervision on balancesheets, so people can believe on companies are reporting.

For sure flooding money to the same mechanisms will not change the output because the transmission mechanism is broken. Its time to fix it.

By the way, IMHO debt durdens are so high because there is an immense quantity of money idle and there is no transformation of debt into equity.
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