Karl posted something that he should have titled “Stream of Consciousness” instead of “Unsubstantiated Claims” where he thought out loud. One of those thoughts landed on the Fisher effect.
My sloppy writing makes it sound as if I am saying Reihan should read up on the Fisher effect. What I mean to say is that Reihan brought up the fact that people fear inflation eroding savings. These fears are common. I have had many a Facebook debate over them. Indeed, Ron Paul has repeatedly pointed to this has his main reason for fearing debasement of the currency.
I believe that the Fisher effect is controversial among Austrians, and Keynes didn’t believe in the relationship at all, except under hyperinflation. Using price inflation in the Fisher equation makes a lot of things confusing, because the composition of output under recession circumstances (less than full employment — or a flat SRAS) is that raising inflation expectations to, say, 3% from 2% will likely cause an increase in real output, leaving inflation at it’s long-run target. Indeed, the Fed isn’t even interested in boosting inflation expectations past its set 2%, and has made that very clear. What the Fed wants is higher NGDP…but unfortunately it operates under a target for nominal interest rates.
Scott Sumner has a post about how inflation is, counterintuitively, good for savers. The thrust of it is that raising NGDP expectations will raise the Wicksellian real interest rate. People will spend more on investment (maybe not consumption, but probably), and we will get far more output, while trend inflation remains intact (and if it doesn’t, then the Fed can act as necessary). This is a boon to savers, as it raises not only the interest rate on savings accounts, CD’s, and the yield on bonds…it raises other asset prices as well, like stocks, real estate, commodities, etc. All are vehicles for saving, and a higher level of NGDP causes every type of investment to increase its yield.
This is the fundamental reason inflation is confusing. People think a lot about cash, but not many people save in cash (as in safes) under a normal positive trend inflation rate — criminals mostly. I think that price inflation is just muddying the debate here, and is completely useless.
A little late, I know, but Happy Thanksgiving everyone!
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Friday ~ November 26th, 2010 at 3:51 am
TomGrey
Price inflation is what Palin and most voters are most concerned about; the reduction of real wages.
Other effects are more confusing, and need more explanation. This post gives a good start, but where in the media are normal people learning about it? Not in Barro’s pro-QE 2 Economist article, nor in the WSJ anti-QE 2 Letter to the Fed, nor in Krugman (?don’t usually read him).
(My earlier thread comment echoes the conclusion that most US homebuyers should want more inflation, so of course I think this is a good post.)
Friday ~ November 26th, 2010 at 7:37 am
sardonic_sob
For purposes of “inflation eats it,” I’d be inclined to think that anything FDIC insured counts as cash. Yes, savings under the mattress are inherently different from savings in a statement savings account, but it’s not like statement savings interest rates vigorously track the CPI. And whether it’s realistic or not, what people who say that “inflation hurts savers” are referring to are people with, say, tens of thousands of dollars in their local bank account, not people with hundreds of thousands of dollars in investments which can be expected to largely track general inflation levels in addition to inherent risk premiums.
Friday ~ November 26th, 2010 at 12:38 pm
Scott Sumner
Just to be clear, I don’t think all inflation is good for savers. I think a little bit more inflation is good when the economy has lots of slack. I base that on the fact that economics is not a zero sum game. If stimulus boosts real GDP, then it also can make both savers and borrowers better off. The real rate earned by savers is higher when the economy is at full employment, compared to when the economy is severely depressed.
Friday ~ November 26th, 2010 at 1:33 pm
Niklas Blanchard
Thanks, Scott. I should have made that more clear.
Monday ~ November 29th, 2010 at 11:16 pm
Ryan Vann
This seemed relatively simple and straight forward, and then I read the Sumner link, and more befuddled than ever. Seems people need to qualify their terms a little better. Increasing real interest rates decrease current bond value, which constitutes a decrease in savings. What should have been said is that increased real interest rates encourage additional savings. Also investing in equities and holding bonds are different scenarios. In one case, that would make you a saver; in the other you are an investor.
Anyway, the general point I am trying to get at is this: Economists, please substitute at least one English class for every third Math class for the sake of us pleibs out here trying to make sense of it all.