Paul Krugman has been on a tear recently pointing out how so many, got it so wrong on inflation. He points out that Keynesian models of all stripes got it right, from the “vulgar Keynesianism” of Y = I + G + C + NX to more sophisticated New Keynesian balance-sheet models.

This is all true.

However, I don’t think its even that deep. I think the bigger lesson here is to not be trapped in intellectual shortcuts and to think carefully about what it is that you are saying. Even die hard Austrians should have been suspect about the possibility for more inflation.


Well, because at root the Price Level is a construct. We can debate whether it is real or ephemeral but mechanically there is no question that we are adding up prices in various markets and then performing a series of calculations on them.

And, absolutely none of us dispute that the prices in each market are determined by supply and demand.

If the price level is to rise, then that means that the prices of actual goods in actual markets must rise as well. That in turn means that supply must fall or demand must rise in actual individual markets.

In what markets did we think this was going to be the case?

We could make some arguments about a decreasing supply of commodities as global demand pulled them away from the US or as a falling US dollar made US demand weaker in comparison to other countries.

However, if we walk market through market in the United States what story are well telling in which we get a sustained increase in the rate at which prices increases.

Think of cars, a major expense for many American families. What is going to cause car prices to rise? Steel is less than 5% of the cost of car. Iron ore significantly less than that. And, America has coal, iron workers and foundries a plenty.

If the price of iron ore shot through the roof what would that really mean for the price of cars.

Clothing takes cotton to be sure. But, more than that it takes seamstresses. Many of those seamstresses work in China, a country whose currency is pegged to our own.

Housing is the major expense for almost all families. We can argue over how to properly measure its price, but with millions of idle construction workers and thousands of idle bulldozers its hard to see where double digit price increases come from.

Food, is trickier. Its shipped around the world. Grain prices in particular are sensitive to international demand. Yet, grain makes up a very small portion of America expenditure on food. Even in the grocery store the processing of most foods is a bigger part of the cost than raw goods.

Fruits and vegetables have an alternate supply chain. Though even here shipping and storage are where the costs really bite. As localvores will tell you, nearby apples in season are practically given away.

Meat really is different. This is one of the few products where you are paying most of the cost for is essentially a product of the earth. Meat prices can and do move big on global fundamentals and for many families this will sting. Still its just one source of spending.

Add to that the fact that Americans spend as much on eating out as they do on eating in. Here the restaurant, the cooks and the servers add even more to cost of a meal.

In short, the cost of most things that American buy comes from the cost of American facilities and American labor. Which means that for the price to go up either the supply of those things has to shrink of the demand has to expand.

There is no reason to think the supply is going anywhere, which means we must be saying the demand is going up.

That then means that we should see individual businesses posting huge increases in sales. That means that we should see a rapid decline in “sales as the biggest problem facing my business.”

We may argue over whether or not such a situation would be ultimately better or worse than the economic slump we are in, but it should be clear that it is not compatible with slump that we are in.

We don’t need IS-LM to see that. We just need to think about what people actually buy and what those markets actually look like. Then we would see that of all the problems we might be facing, double-digit inflation is not one of them.