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Originally Posted by AndrewC  I've been reading a blog written by a deflationist. This individual has been writing about deflation for a couple years. He has convinced me that we are experiencing deflation not inflation. Of course he defines inflation and deflation as the expansion and contraction of the money supply. He follows the Austrian method that focuses on money supply rather than prices. |
By the definition that Mish uses concerning money supply, it may be possible for him to argue that the macroeconomic environment is deflationary when the price data shows inflation. However, having said that, the
monetary base (M1 and M2) continues to expand not contract. Derived figures for M3, which is no longer reported, also shows a continuing expansion.
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He has detailed several reasons why prices and CPI are a poor indicator. One, what factors influence price. How much does each factor influence price? Different factors affect different items and so on. For instance, I don't think anyone on this board would deny that oil and food are rising for reasons other than inflation and a falling dollar. What percentage of the price increase is due to supply, demand, weather, politics and falling dollar no one knows. So it is ridiculous to suggest that food, energy and other consumer price increases are a worthwhile barometer of anything.
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The Consumer Price Index is merely one price indicator albeit a widely watched one. The data gives the weights for the basket of goods that is referenced. One can get broader price data from the GDP reports and from the personal consumption expenditures reports.
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Second, CPI and government inflation data focuses on a small portion of items in our economy. What about housing? How can you claim price increases when home values are down so much. Billions have been written off by banks. Do these price changes not matter to inflation index? The increases in food and energy pale in comparison to the loses in housing and commercial real estate.
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In my opinion, a broader price index that includes asset valuations should be employed. While some would argue that home prices or stock prices should not be treated as inflation per se, I disagree. If consumer spending (consumption and investment) is increasing faster than income (as happens in credit booms), and the excess isn't showing up in higher inflation, it is feeding a rise in asset prices. When asset bubbles implode, they inflict economic damage. Per IMF research, real estate bubbles typically inflict about twice the damage in terms of lost output (GDP) and their adverse impact lasts about twice as long as that associated with stock market bubbles.
Unfortunately, monetary policy is too blunt a tool to deal with asset bubbles. Smart regulation can play a role in reducing the prospects, though not necessarily preventing, the rise of such bubbles.
I am familiar with Mish's blog. With respect to the interest rate trends he sites in his piece "Now Presenting: Deflation!" much of the downward trend one has witnessed has resulted from Fed rate reductions (this impact applies particularly to the shorter-end of the yield curve) and expectations for an economic slowdown. Fed Chairman Bernanke is an expert on the Great Depression. The Great Depression was a deflationary event and he has been worried about the implosion of the housing bubble setting off a deflationary debt spiral.
The implosion of bubbles is deflationary. However, what makes this bubble implosion different from Japan's situation (real estate and stock bubbles imploded almost simultaneously), is that it occurs in the midst of a broader inflationary macroeconomic environment. At this time, inflation expectations are rising, monetary policy is not constrained by the gold standard, and aggregate supply-demand interactions on a global basis are helping fuel some of the inflation.