Wednesday, June 10, 2009

Inflation & Deflation

Robert Samuelson had an interesting piece in The Washington Post on Sunday.

In it, he discusses price stability, approaching it as a discussion of whether we face a greater threat from inflation (a general rise in prices) or deflation (a general fall in prices). He cites two eminent economists: Alan Meltzer who believes inflation is the greater threat, and Paul Krugman who sees deflation as more likely. If we judge from recent actions of the Federal Reserve, they're lining up with Dr. Krugman. But we'll find out more on June 23 when the Federal Open Market Committee (FOMC) concludes its next meeting. The current Summary of Current Economic Conditions (Beige Book) certainly doesn't seem to presage an inflation problem.

But Samuelson's article has value beyond the discussion. In it, he refers fleetingly to the role of consumer expectations. This idea is important. Essentially, this means that whether the nation experiences inflation or deflation depends partly on what we expect as participants. For these expectations will likely influence our actions. If we expect inflation, we likely will start acting in ways that will help inflation along - spending rather than saving to avoid price increases for example. If we expect deflation, we will like go the other way - holding back on spending out of fear of a slower economy which would only slow things further.

But Samuelson goes on to make a more important point. And that point has to do with the structure of the Fed. Mr. Bernanke's term as Chairman of the Board of Governors ends in January. And Chairman Bernanke is on record that the Fed has pledged to preempt high inflation. That pledge is highly valued because it is based on the credibility of his predecessors, Paul Volcker and Alan Greenspan, as inflation fighters, and stretches back more than 25 years. Samuelson points out that nominating Bernanke for a second term as Chairman could do much to eliminate uncertainty and could offer some sense of commitment to price stability to all participants in the economy.

What are your thoughts? Do you discuss the role of expectations with your students? And do you think the Fed's leadership has any impact on expectations? I know the school year is about over, but hopefully we can continue discussions, and help you get some ideas for next fall. I look forward to your thoughts.

One of this blog's regular readers pointed out two additional items for consideration. The first is this opinion piece by Arthur Laffer from today's edition of The Wall Street Journal. Laffer falls squarely in the more inflation camp.

The second is this speech by Jeffrey Lacker, President of the Federal Reserve Bank of Richmond before the North Carolina Senate Appropriations Committee. President Lacker is an inflation hawk, and although that might cause you to place him in the same camp with Laffer and Meltzer, take a look at the final few paragraphs of his speech where he addresses inflation. He evidently doesn't fall into the inflation or deflation camp at the moment, expressing confidence that consumer expectations are firmly anchored at the moment.

This post references the following Keystone Economic Principles:
4. Economic systems influence choices.
5. Incentives produce "predictable" responses.
7. Economic thinking is marginal thinking.
9. Prices are determined by the market forces of supply and demand… and are constantly changing.

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