Silent Inflation
Inflation targeting is supposed to reduce
uncertainty about prices. But keeping the inflation target at 2% or more, might
actually increase a sense of uncertainty about real things like home values or
investments.
NEW
HAVEN – In many countries, inflation has become so low and stable in
recent decades that it appears to have faded into the woodwork. Whereas
galloping inflation was once widely viewed as the number one economic problem,
today most people – at least in the developed countries – hardly ever talk
about it or even pay attention to it. But “silent inflation” still has subtle
effects on our judgment, and it may still lead to some consequential mistakes.
Since New Zealand’s central bank set the first example in 1989, monetary
authorities around the world have increasingly pursued a policy of setting
inflation targets (or target ranges) that are substantially above zero. That
is, policymakers plan to have inflation, but steady inflation.
What used to be a dirty word is now announced publicly, and moderation is
enforced.
Central Bank News tabulates these targets for 68 countries.
The European Central Bank targets annual inflation in 2018 at “below, but close to, 2%.” In Canada, Japan,
South Korea, Sweden, the United Kingdom, and the United States, the 2018
inflation target is 2%. China and Mexico target 3% annual price growth. In
India and Russia, the target rate is 4%. It is 5% in Ukraine and Vietnam, and
6% in Azerbaijan and Pakistan.
Some countries have had double-digit inflation targets. Egypt has set a
target of 13%, plus or minus 3%, for this year. But most countries have set
their 2018 inflation targets at between 2% and 6%.
It is worth translating these annual inflation targets to longer-term
inflation, assuming that the target is not changed in coming years. Inflation
of 2% per year implies 22% inflation over a decade, or 81% inflation over 30
years. That will make numbers measured in currency look a lot bigger over time,
even if nothing real is changing.
It is a lot worse if one considers a 6%
inflation rate. At that pace, prices would rise 79% in ten years and almost
six-fold in 30 years.
At the same time, in an age of Internet rumors and fake news, the world
today can look a little unmoored from history. That might create a sense of
real risk.
Inflation targeting has other effects, too, which seem to be more on the
minds of central bankers.
In his influential 1998 book Inflation
Targeting, Ben Bernanke and his co-authors advised policymakers
to announce a target inflation rate because it “communicates the central bank’s
intentions,” which would “reduce uncertainty.” The announced rate should be
substantially positive, they wrote, because if officials tried to get it close
to zero, any mistake could result in deflation, which “might endanger the
financial system and precipitate an economic contraction.” As Federal Reserve
Chair from 2006 to 2014, Bernanke formally introduced inflation targeting in the United
States in 2012, setting the annual rate at 2%, where it has remained ever
since.1
But reducing uncertainty about prices by keeping the inflation target at
2% or more might actually increase a sense of uncertainty about real things
like home values or investments. While it is right to worry about massive
deflation, the historical relationship between deflation and recession is not all
that strong. In a 2004 paper, the economists Andrew Atkeson and Patrick Kehoe
concluded that most of the evidence of a relationship comes from just one case:
the Great Depression of the 1930s.
The news media’s tendency to fixate on new records serves their
short-term interest in creating the impression that something really important
has happened that justifies readers’ or viewers’ attention. But sometimes there
is a bit of fakery in the record, especially when the record is described in
nominal terms and we have steady inflation. As a result, the emphasis on
records can encourage a disrespect for history and nurture a sort of
disoriented feeling that we live in exceptionally uncertain times.
For example, sometimes the stock market has set a new record, whether up
or down, which is nothing more than the result of inflation. On February 5 of
this year, the Dow Jones Industrial Average fell 4.6%, far below the record
22.6% decline on October 19, 1987. But media reports chose to point out that the February 5 drop
was the biggest-ever one-day decline in absolute terms (1,175
points on the DJIA). Presenting a drop this way is misleading, and might
encourage some panic selling. The amplitude of stock-market point swings
invariably grows with general inflation in all prices.
The money illusion even bleeds into impressions of the “strength” of the
economy, as if a high level of GDP growth or a bull market are indicators of
the health of something called the economy. GDP growth numbers are
conventionally reported in real (inflation-adjusted) terms, and unemployment
numbers are unit-free. But reporting of just about every other major economic
indicator is generally not corrected for inflation.
An inflation target of a few percentage points may seem to promote
stability, and perhaps it really does. But we need to consider the possibility
that it may lead to subtle misperceptions that have the opposite effect on the
stability of our judgments.
Writing for PS since 2003
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123 Commentaries
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Robert J. Shiller,
a 2013 Nobel laureate in economics, is Professor of Economics at Yale
University and the co-creator of the Case-Shiller Index of US house prices. He
is the author of Irrational Exuberance, the third edition of which was
published in January 2015, and, most recently, Phishing for
Phools: The Economics of Manipulation and Deception, co-authored
with George Akerlof.
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