Bad explanation for inflation AIER

Although inflation is empirically difficult to digest in its constituent parts, its essence is simple. Inflation occurs when too much money runs after very few products. Milton Friedman popularized this rule. The combination of its comprehensibility and explanatory power explains why it is still widely used.

But not everyone got the memo. Politicians, bureaucrats, journalists and very online ™ academics are searching hard for other reasons Let’s consider some of the worst explanations for inflation.

“Greedy corporation!”

This is the worst explanation for the favor of progressives in Congress, especially Senator Elizabeth Warren. Corporations are always greedy. They want to make as much profit as possible. Yet inflation is rarely as high as it is now. The last time we saw the rapid devaluation of the dollar was 40 years ago. You cannot explain a variable effect by a constant factor. Gravity does not cause one’s trip and fall. Greed does not cause inflation.

“Market power!”

In economics, “market power” means the ability of companies to charge higher prices than marginal costs. Proponents of the market-strength explanation for inflation point to a rise in density in a number of industries over the past two years.

For the sake of argument, the density of the auction industry has increased. It still does not explain inflation.

First, the connection between density and market strength is weak. Sometimes concentration is driven by structural economic factors – an efficient response to changing economic conditions. When this happens, there is no corresponding market strength increase.

Second, the argument of market power is confusing Level Price for Growth rate Price inflation refers to the latter. Even if the market allows power companies to raise prices, it will be a one-time event. Inflation will rise temporarily, then return to the trend. Instead, we have a long-term up-trend inflation. It’s not just yoga.

“Wage-price spiral!”

Some bad explanations never die. The wage-spiral approach was the mainstay of Keynesian (pseudo-) inflation from the middle to the end of the 20th century. What was bad then is bad now.

Presumably, workers demand higher wages because of rising prices, which results in firms still charging higher prices and even breaking even. This is a positive feedback loop. However, it has two serious flaws. One is conceptual. The other is realistic.

Conceptually, there is no point in wages surpassing the productivity of workers. Firms cannot pay workers more than the price they pay, these workers add to the bottom line of the firm. If you own a sandwich shop, and you think hiring a potential employee would add $ 15 per hour, would you be willing to pay him or her the most for working? If you pay him more than $ 15 per hour, you lose money. The dollar amount of labor output, which economists call Marginal revenue product of laborUpper limit on wages.

In fact, inflation has outpaced wage growth over the past few months. The CPI rose 8.6 percent year-on-year, while nominal (dollar-value) wages rose only 5 percent. That means workers have effectively reduced wages (i.e., after adjusting their wages for inflation). What is the wage-price spiral? If anything, companies are getting a deal!

“Cost-push!”

I’ll take 400 for questioning, Alex! This theory of inflation states that businesses carry higher costs to consumers in the form of higher prices (“push”). But this is not an explanation. It’s just repeating things to explain. Why are costs rising? You’re back to where you started.

Improving public discourse

Hopefully, these heinous explanations will soon go out of the consciousness of the people. What we need to focus on: the relative abundance of money compared to the product. To put it bluntly, this does not mean that inflation is 100% money-driven. I am sure that the prolonged supply-chain problem from the epidemic and the ongoing war in Ukraine are part of the problem. Furthermore, we should be careful in weighing the financial vs. non-financial factors.

My Sound Money project colleagues have done a good job (here, here, here, here and here recently) showing money is very important now. This is not a complete explanation, but it is the biggest part. Equipped with this knowledge, and vaccinated against some of the stupid interpretations prevalent today, we can work towards policy solutions to restore control over the value of the dollar.