FacebookTwitterGoogle+RedditEmail

Is the Economy Too Simple for Economists to Understand?

by DEAN BAKER

The collapse of the housing bubble and the subsequent devastation to the economy caught almost the entire economics profession by surprise. Federal Reserve chair Alan Greenspan, along with other people in top policy positions, were left dumbfounded. They didn’t think a prolonged downturn was possible. They were wrong in a really big way.

The current group of central bank chairs and other top policymakers would like us to believe that they’ve learned their lesson and now everything is under control. They want us to think they actually have a clue about how the economy operates. There is good reason to believe otherwise. The European Central Bank (ECB) recognizes that inflation has been running below its 2% inflation target and is likely to stay below that target for several years to come. But the ECB has reassured the public that’s prepared to act, making sure that the eurozone doesn’t see deflation. That the bank cares about the inflation rate crossing zero and turning negative is a sign that it has no clue about how the economy works.

The point here is incredibly simple – apparently too simple for the ECB to understand. The inflation rate in the eurozone is too low right now. If it falls below zero and turns negative, this problem becomes more serious, but there is no qualitative difference between a drop from 1.5% inflation to 0.5% inflation and the drop from a 0.5% inflation rate to a -0.5% inflation rate.

To understand this dilemma, you just have to understand what the inflation rate is. It’s an aggregate of millions of different price changes. When the rate of inflation is near zero, there will be tens of thousands of prices that are falling. But these will be outweighed by the prices that are increasing, thereby making the aggregate inflation rate positive. What possible difference can it make to the economy if the mix of falling prices and rising prices goes from 45% falling and 55% rising to the opposite?

Another factor that shows the absurdity of deflationary fears is another pretty simple one: prices in our indices are quality adjusted prices. The price that people pay for a car or a computer may rise year-to-year, while the inflation index shows a decline for these items.

This would happen if the statistical agency calculated that the quality improvements were larger than the price increases, leading to a fall in the quality adjusted price. So we are supposed to believe that the economy is in trouble if the quality of computers and cars starts to increase more rapidly?

One of the oft-repeated deflation horror stories only needs a moment’s thought to realize its absurdity. Supposedly, if prices start to fall, then consumers will put off purchases. Really? If the price of a $30 shirt is falling at an annual rate of 0.5%, will many people delay buying a new shirt for six months to save 8 cents? Even in the case of a $20,000 car, delaying the purchase for a year only saves a consumer $100.

Of course, the quality adjusted price of computers has been falling for decades. This sector has not exactly been struggling.

Sometimes we hear a story of a deflationary spiral, wherein deflation reduces demand, leading to more deflation and a still further drop in demand. It’s a great story, but no one has seen anything like this since the start of the Great Depression. Even in the Japanese deflation horror story, the rate of annual deflation never exceeded -1.0%.

Incidents of runaway deflation, like hyperinflation, are extremely rare and would occur under extremely unusual circumstances. Both may make for good fairy tales for the kids, but they are not the sort of thing with which serious people need concern themselves.

While the concerns about deflation can be dismissed as silly children’s tales, there are two reasons that we should be troubled by their appearance in policy discussions. The first directly relates to current policy.

The eurozone is suffering from a lower than desired inflation rate now. With the overnight interest rate near the zero bound, the real interest rate cannot fall further unless the inflation rate rises. Since a lower real interest rate would help move the economy to full employment, the ECB should be trying to raise the inflation rate, not saving its ammunition against the risk that the inflation rate would turn negative. The menace of deflation provides an absurd excuse for inaction.

The other reason that we should be troubled by deflation talk is that it seems our top policymakers still don’t have the most basic understanding of the economy. The failure to see the bubbles was not a one-time lapse in judgment, it stemmed from seriously confused thinking about the economy. There really was no excuse for an informed economist not to recognize these bubbles and the threats they posed. It doesn’t appear that much has been learned in the last six years. The basic problem is that the economy is far too simple for economists to understand.

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University. 

This article originally ran on the Guardian.

 

 

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

More articles by:

CounterPunch Magazine

minimag-edit

bernie-the-sandernistas-cover-344x550

zen economics

May 30, 2017
Clancy Sigal
Even Grammar Bleeds
May 29, 2017
Jim Kavanagh
No Laughing Matter: The Manchester Bomber is the Spawn of Hillary and Barack’s Excellent Libyan Adventure
Vijay Prashad
The Afghan Toll
Melvin Goodman
The Washington Post’s Renewed Attack on Whistlblowers
Robert Fisk
We Must Look to the Past, Not ISIS, for the True Nature of Islam
Dean Baker
A Tax on Wall Street Trading is the Best Solution to Income Inequality
Lawrence Davidson
Reality and Its Enemies
Harry Hobbs
Australia’s Time to Recognize Indigenous Peoples’ Sovereignty
Ray McGovern
Will Europe Finally Rethink NATO’s Costs?
Cesar Chelala
Poetry to the Rescue of America’s Soul
Andrew Stewart
Xi, Trump and Geopolitics
Binoy Kampmark
The Merry Life of Dragnet Surveillance
Stephen Martin
The Silent Apartheid: Militarizing Architecture & Infrastructure
Weekend Edition
May 26, 2017
Friday - Sunday
Anthony DiMaggio
Swamp Politics, Trump Style: “Russiagate” Diverts From the Real White House Scandals
Paul Street
It’s Not Gonna Be Okay: the Nauseating Nothingness of Neoliberal Capitalist and Professional Class Politics
Jeffrey St. Clair
The ICEmen Cometh
Ron Jacobs
The Deep State is the State
Pete Dolack
Why Pence Might be Even Worse Than Trump
Patrick Cockburn
We Know What Inspired the Manchester Attack, We Just Won’t Admit It
Thomas Powell
The Dirty Secret of the Korean War
Mark Ashwill
The Fat Lady Finally Sings: Bob Kerrey Quietly Resigns from Fulbright University Vietnam Leadership Position
John Davis
Beyond Hope
Uri Avnery
The Visitation: Trump in Israel
Ralph Nader
The Left/Right Challenge to the Failed “War on Drugs”
Traci Yoder
Free Speech on Campus: a Critical Analysis
Dave Lindorff
Beware the Supporter Scorned: Upstate New York Trump Voters Hit Hard in President’s Proposed 2018 Budget
Daniel Read
“Sickening Cowardice”: Now More Than Ever, Britain’s Theresa May Must be Held to Account on the Plight of Yemen’s Children
Ana Portnoy
Before the Gates: Puerto Rico’s First Bankruptcy Trial
M. Reza Behnam
Rethinking Iran’s Terrorism Designation
Brian Cloughley
Ukraine and the NATO Military Alliance
Josh Hoxie
Pain as a Policy Choice
David Macaray
Stephen Hawking Needs to Keep His Mouth Shut
Ramzy Baroud
Fear as an Obstacle to Peace: Why Are Israelis So Afraid?
Kathleen Wallace
The Bilious Incongruity of Trump’s Toilet
Seth Sandronsky
Temping Now
Alan Barber – Dean Baker
Blue Collar Blues: Manufacturing Falls in Indiana, Ohio and Pennsylvania in April
Jill Richardson
Saving America’s Great Places
Richard Lawless
Are Credit Rating Agencies America’s Secret Fifth Column?
Louis Proyect
Venezuela Reconsidered
Murray Dobbin
The NDP’s Singh and Ashton: Flash Versus Vision
Ron Leighton
Endarkenment: Postmodernism, Identity Politics, and the Attack on Free Speech
Anthony Papa
Drug War Victim: Oklahoma’s Larry Yarbrough to be Freed after 23 Years in Prison
Rev. John Dear
A Call to Mobilize the Nation Over the Next 18 Months
Yves Engler
Why Anti-Zionism and Anti-Jewish Prejudice Have to Do With Each Other
Ish Mishra
Political Underworld and Adventure Journalism
FacebookTwitterGoogle+RedditEmail