When reality persistently challenges a deeply held belief, believers can get a little weird. Conservative economist Amity Shlaes, never the steadiest of heads in the best of times, recently joined the frustrated ranks of the inflation cranks with a bizarre rant in the National Review.
Shlaes is now convinced that the inflation which her models predict is being hidden somehow. Her evidence? Movie tickets, among other items, now cost more than they used to. Since data has abandoned her and rest of the true believers in right-wing economics, she has fled to the hills of anecdote where she can be safe from cognitive dissonance. Inflation is invisible to all but the pure at heart.
This development highlights the wider dilemma facing Economics as a discipline. Though it claims to be a science and sometimes pretends to be engineering, Economics at this stage of development is no more than a philosophy dressed up in equations. It may be possible to explain the mystery of the “missing inflation,” but only by stepping outside the quasi-religious boundaries of economists’ favorite models.
Since the Nineties, western governments have embraced monetary policies designed to stimulate their economies without the political complication and inflation risks of direct economic stimulus. By toggling the costs and availability of financial institutions’ access to wholesale lending, governments could influence the economy by adjusting access to capital rather than directly placing more currency in citizens’ pockets.
Funny enough it was conservative economists, particularly Milton Friedman, who pioneered this model. Since the financial crash we’ve seen the most aggressive use of monetary policy ever deployed in an effort to halt our terrifying deflationary cycle. In fairness to conservatives like Shlaes, it is perfectly reasonable to worry about how such an unprecedented and massive new intervention might impact the economy. No one really knows the implications of having the Federal Reserve purchase trillions of dollars of mortgage backed securities and Treasury Bonds. In theory, the Fed can simply hold them permanently with no economic impact, but that sounds a lot like simply printing money. Why wouldn’t that create inflationary pressure?
One explanation for the absence of inflation in response to the Fed’s loose money strategy is that the deflationary damage of the financial collapse was so severe that we haven’t fully “re-inflated” the economy yet. That is more or less the consensus view. However, there may be another explanation.
Perhaps the method chosen by Western governments to reinflate their economies has had a perverse effect. By pouring stimulus directly into financial institutions rather than into the hands of consumers those resources are fueling a different kind of inflation, inflated asset or capital values. Perhaps changes in the way our financial markets function over the past generation mean that this form of stimulus is becoming less and less effective as an economic tool. In other words, facts on the ground have broken the theoretical model. Again.
In theory, “capital inflation” should be impossible. Money made available to capital markets should flow directly into productive investment, creating new value in the economy. What if the funds being disbursed by the Federal Reserve are not going into productive investment in the way that we might expect? Once upon a time, banks made money lending to people who invested that money in capital improvements. If that model no longer exists, or is no longer the dominant explanation of how banks make money, then perhaps money poured into the banking system will not flow into productive investment. Maybe all we’ve done is put more chips on a casino table.
After juicing the system with trillions of dollars of Fed leverage, we are seeing no evidence of looming inflation or any accompanying boom in economic growth. We are however seeing a boom in asset prices. The economy has limped along for seven years, with sluggish employment growth and consistently weak GDP numbers. Weak economic indicators have been accompanied by a historic bull market in stocks, accompanied by booming values in a wide variety of asset classes. Even investment in Treasury bonds, which should sag in an equity boom, is high.
Just as in the last decade, an economist who opens a window and sees what’s happening anecdotally on “Main Street” might find some helpful clues. In my suburban Chicago neighborhood the housing market looks eerily like the nosebleed highs of 2006. Houses flip in days with offers exceeding asking prices. Rentals are tough to find.
Meanwhile just a few miles away lower income neighborhoods continue to slog through the long tail of the foreclosure crisis. Markets in DC, Northern California, Chicago, and the NYC suburbs have returned to boom conditions while elsewhere they remain largely stagnant.
Nearly anyone with good credit and/or significant exposure to capital markets is experiencing an economy completely removed from the experience of Americans who used to live in what we once called a Middle Class. Whoever had enough money to weather the financial collapse is now seeing boom conditions float them away to a better future. Those whose boats were wrecked are drowning on this rising tide.
Money flowing into capital markets does not seem to be fueling productive investment. It looks very much like we responded to the damage of the last market bubble by simply creating another one. The inflation that far right economists like Shlaes insist on finding does exist in a sense. They will not recognize it because it defies their models and leads to implications that they do not wish to acknowledge.
Fed stimulus has limited deflation only by propping up speculative markets in assets like oil, real estate and food which might otherwise have dropped even further and remained even lower. This intervention seems to have benefited the owners and speculators in those assets while accomplishing very little for people who have to earn a living from wages.
If this approach isn’t creating inflation, then what is the harm? Frankly, no one seems to know. Unprecedented acquisition of assets by the Fed and massive new money loaned into the banking system is an experiment and we haven’t yet seen the results.
We can predict that prolonged asset inflation will lead to asset crashes. We have been seeing these with increasing frequency over the past generation. Sometimes these crashes can have broad destabilizing effects, as in 2007. Other times, as with smaller collapses recently in gold, or cocoa, copper the impacts are more localized. The overall effect though, so long as this kind of economic juicing remains in effect, is a steady exacerbation of structural inequality and the occasional evaporation of accumulated wealth. Not exactly the kind of thing Amity Shlaes wants to talk about.
With repeated use, monetary policy may be losing some of its effectiveness. It seems to be generating unintended consequences which the economic models currently in vogue may be missing. That happens. Hopefully we won’t need another economic catastrophe to jolt economists into rethinking their models, but there is little sign of a major rethink on the horizon.