I am an extreme Inflation dove and complain that heads they win tails I lose

The point of this post is that I see an odd consensus about the conclusion based on opposite assumptions. The conclusion is the standard conclusion that US inflation is currently definitely too high and that it is necessary to reduce it even at the risk of a recession.

First the US public considers current US inflation to be a very bad problem. It is easy to see why. Normal people use “inflation” to mean price inflation and assume given nominal income, so inflation so defined implies declining real income (pdf warning).

In contrast economists use inflation to imply an increase in the price level without changes of relative prices which means without changes of real wages or real interest rates. From a certain point of view (OK my point) I say that people hate inflation, because they don’t know what it is.

The problem with my smug dismissal of most people is that, in fact, the recent US inflation has caused a reduction of real wages (I am making a concession so I feel free to assert causation). I think this is the effect of an increase in inflation. I think it is also the effect of unexpected inflation. Finally, I think htat in the current USA the two are the same (expected is equal to lagged inflation either because expected inflation is anchored around 2% and lagged inflation was about 2% or because expected inflation is unanchored and equal to lagged inflation).

Here I think people assess what it is like if something is high or low by measuring what happens when it switches from low to high or from high to low. I note that psychologists agree. This can be misleading. For example, it helps people get addicted to drugs — starting some drugs is pleasant and stopping unpleasant even if constant use is neutral (except for risking jail if they are illegal). There is strong evidence for the claims that people are pleased with sleeping pills and sleep no better using them regularly than they did before starting them.

So if increased inflation hurts and decreased inflation is pleasant, people will decide that inflation makes them poorer. This would be true even if steady inflation of any moderate rate had no effect on real income.

The standard assumption made by economists is that there can be different steady inflation rates with all but one real variable unaffected by the rate of inflation. I think that this standard assumption might actually be accurate. The one variable is the real value of money balances which is lower with higher inflation. This is a cost of inflation (the “shoe leather” cost) as real balances are produced at zero cost so welfare is maximized (in standard simple models) if any desire for liquidity is satiated (so the economy is at the zero lower bound). This cost can be estimated and is all estimates of it are very small (tiny compared to the cost of a recession).

But economists accept that we have been assigned the job of controlling inflation. In particular that people (including policy makers) will accept a recession if it is the only way to fight inflation.

Oddly the most theory inclined economists have no problem with placing a very high priority on low inflation. This is exactly because they think different inflation rates have no effect on real variables, so low inflation can, in the long run, be obtained at zero cost.

In contrast the fact that surprise inflation causes low real wages is feared as it is believed that policy makers will be tempted to inflate in order to achieve low real wages. Back before the long period of low inflation, there was a very large literature on this issue (see “dynamic inconsistency” “monetary policy”). This was crazy. People are infuriated by reduced real wages and policy makers are terrified of that fury.

The point (if any) of this post is the very odd alliance of people who disagree about everything except that inflation must be kept low. The regular people think inflation has a long term effect on real wages and this is bad. The fresh water macroeconomists think inflation does not cause persistently lower real wages (which would be good). Both agree that low inflation should be the number one priority — one because inflation has huge costs and the other because inflation fighting has tiny costs.