A Bob Murphy-Noahpinion Dustup Over Inflation

     This is the kind of thing that if you're an economist-or an interested layperson like myself-that you relish. You may even find it sexy-which no doubt will perplex those with little understanding or interest in economics.

     However, inflation is one of those subjects that I find endlessly fascinating. Some-particularly Austrians-among them particularly Rothbardians-think it's an unmitigated evil. Others reason that it's the price of civilization.

    This latest cage match got started over Noahpinion-Noah Smith-attempting to answer a question of someone on Twitter who poised a question to Noah. Bob Murphy found Noah's answer "patronizing."

    

Inflation is one of those things that almost nobody who isn’t an economist seems to understand…
Or the other day, someone on Twitter asked me: “How is it possible for inflation to help debtors when wages are going down? If wages are going down, doesn’t inflation just make it harder for people to pay off their debts?”
The answer is no. Here’s why. Suppose you make $50,000 a year and you have $50,000 in debt. Your debt-to-income ratio is 1. Also, just for convenience, let’s say the general price level starts out at “1″.
Situation A: -50% real wage growth, 100% inflation.
In this case, the new price level is 2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 2 = $50,000. Your debt is still $50,000. Your debt/income ratio is still 1.
Situation B: -50% real wage growth, 0% inflation.
In this case, the new price level is 1. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1 = $25,000. Your debt is still $50,000. Your debt/income ratio is now 2.
Situation C: -50% real wage growth, 50% deflation.
In this case, the new price level is 1/2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1/2 = $12,500. Your debt is still $50,000. Your debt/income ratio is now 4.
So as you can see, even if your real wage is going down by 50%, it’s better to have inflation than no inflation if you are a net debtor. Inflation erodes the value of your debt no matter what is happening to your real wages.
So what’s going on here? Why do so many people misunderstand inflation? Maybe it’s a form of “Stockholm Syndrome”. Inflation-hawkish economists have been bellowing, so loudly and so vehemently, that inflation is Satan – this goes back at least a hundred years – that non-economists just can’t help believing it. People end up trying to think up reasons why inflation must be bad after all. When you offer them freedom – when you tell them that sometimes inflation can erode debt, relieve balance sheet recessions, and help stimulate the economy – they don’t want to take it. , and they come up with more brilliant ways to identify with their captors. Or something like that.
 

       Murphy responded in a comment this way:

       "Mr. Pinion, in my humble opinion you have totally overanalyzed the Twitter question and ended up speaking nonsense. The guy wasn’t asking you about real wages, he was asking about actual nominal wages."

       "So his point was something like this:

        “Hey Noah, I get how if all prices double, including my hourly nominal wage rate, then it becomes easier for me to pay off my fixed debt. But if I’m having trouble making ends meet and keeping up with my loan repayment plan, then my employer actually cuts my nominal paycheck, and then on top of that the price of food and health insurance goes up, how in the world does that make me better off?!”

         "It doesn’t. By interpreting your Twitter guy to be speaking of real wages, you completely dodged his simple question."

          "Why is it that so many economists can’t understand simple questions about inflation? Must be political."

          http://consultingbyrpm.com/blog/2012/11/noah-pinion-shows-yet-again-that-economists-will-be-strung-up-right-after-investment-bankers.html#comment-51057

          I'm not sure why he found the answer patronizing. Maybe because Noah spoke of noneconomists as not being able to understand it? Is it wrong to ever suggest that noneconomists don't understand something that economists do?

          Some commentators at Bob's didn't take his point either, apparently. He then gave his own counterexample:

         
UPDATE: "So in the comments, it turns out that not 1, not 2, but 3 of my clever critics think I’m missing Noah’s “point.” OK watch this. I’m going to paste Noah’s 3 scenarios, and then add one more that is done in exactly the same style, but with a 200% 300% (price) inflation rate. Watch what happens:

Suppose you make $50,000 a year and you have $50,000 in debt. Your debt-to-income ratio is 1. Also, just for convenience, let’s say the general price level starts out at “1″.
Situation A: -50% real wage growth, 100% inflation.
In this case, the new price level is 2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 2 = $50,000. Your debt is still $50,000. Your debt/income ratio is still 1.
Situation B: -50% real wage growth, 0% inflation.
In this case, the new price level is 1. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1 = $25,000. Your debt is still $50,000. Your debt/income ratio is now 2.
Situation C: -50% real wage growth, 50% deflation.
In this case, the new price level is 1/2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1/2 = $12,500. Your debt is still $50,000. Your debt/income ratio is now 4.
[Added by RPM:] Situation D: -50% real wage growth, 200% 300% inflation.
In this case, the new price level is 4. Your new real wage is $25,000. Your new nominal wage is $25,000 x 4 = $100,000. Your debt is still $50,000. Your debt/income ratio is now 1/2.

     "Wow, I just proved Noah’s point even more so, right? Look at that, the guy’s debt/income ratio dropped from 1 down to 1/2. So clearly 200% 300% inflation is even better than 100% inflation. Noahpinion FTW!"

     "Oh wait a minute. By using Noah’s technique, and picking an inflation rate of 200% 300% rather than Noah’s (completely arbitrary) 100%, now I’m making the guy get a pay increase from his employer. This is clearly NOT what the Twitter guy had in mind, proving that Noah is answering a different question."

     "This is really simple, everyone: If I am struggling to pay my bills, including fixed-rate debt payments, and then you’ll tell me prices are going to go up by 10% next year, I don’t care what happens to this particular fraction called “debt/income.” What I want to know is, will my nominal paycheck go up by 10% as well? If so, then I’m golden. If it goes up, but by less than 10%, I conceivably could still be better off–it depends how big a fraction my fixed-rate debt payments originally are of my total budget."

     "But under NO CIRCUMSTANCES would I want to see prices go up, if at the same time you tell my wages are going to go down too. Instead of that outcome, I would rather see prices stay the same.
Putting it another way: For a given nominal wage and nominal debt payment, I am better off if prices go down. Duh. I don’t care if that raises the “real burden of my debt.”

     "If you want to say this guy’s question doesn’t understand basic price theory, and that it’s kind of goofy to assume prices could rise while leaving blue collar workers in the dust, OK…but that’s the narrative progressives have been telling about Ronald Reagan-George W. Bush’s America. I actually think that’s what prompted the Twitter guy’s question. He was having cognitive dissonance on why the Keynesian heroes were simultaneously championing inflation to help debtors, but also worrying about income gains accruing largely to the fat cats."

     Note how derisively Bob uses words like "clever." Anyone who thinks inflation is not an unmitigated bad thing is "clever." I don't really get how his counterexample proves Noah was answering a different question.

     For the most part, you don't expect to see a nominal wage cut with inflation rising anyway. How much your nominal wage would rise vs. the prices of the things you have to buy depends on different factors. But in an economy with a 100% price rise there wouldn't be many jobs with nominal wage cuts. Of course, the 100% number is unrealistic and Noah used it just to make the illustration simple.

    But I don't think there's anything condescending to point out to the Twitter guy that for the most part his wages aren't going to go down with rising prices. Companies are mostly loath to do nominal wage cuts. They much prefer to downsize and cut back on hiring. They don't want to cut the wages of people still working for them-as it's a major disincentive.

    There seems to be some quibbling over what the Twitter guy really meant. Is Noah wrongly thinking he meant his real wages when he actually was asking about nominal wages? But normally, nominal wages won't go down with inflation rising. When Bob says this:

    "For a given nominal wage and nominal debt payment, I am better off if prices go down."

     this basically means "all things being equal, I'm better off if prices go down."But are things ever equal? You're assuming that the nominal wage and debt payment won't be affected by the drop in prices.

     Seems to me the Transformer commentator does a good job of crystallizing the real point in his comment here:

     "I take Pinion to be looking at a situation (like we are probably in now) where real wages need to fall for employment to increase."

     "The question then is “is it better for real wages to fall via a a drop in nominal wages or via inflation in non-wage goods”

      It was Keynes who said workers are right to resist a drop in nominal wages more strongly. I'm not sure what Murphy is after here. It seems to me that he wants to argue that the man in the street is right to see inflation as unmitigated evil that is to be avoided at all costs.

     It's somehow "condescending" to ever disagree with the man in the street's gut feelings about inflation according to Bob. It seems clear that inflation benefits some and disbenefits some. The question would be what is its overall , net macro effect. Of course, at least some Rothbardians like Bob don't even allow us to speak of the macro level-good example of this is Major Freedom who is a frequent commentator at both Bob and the Money Illusion.

     I wrote recently of that book about Jimmy Carter's economy by Carl Biven I'm currently reading.

     http://diaryofarepublicanhater.blogspot.com/2012/11/an-inordinate-fear-of-inlfation-jimmy.html

     Biven's basic premise about Carter is that he lost the election in 1980 dur to intractable problems that were out of his control-symbolized most vividly by the Iranian hostage crisis and inflation.

      Carter himself looking back has argued that inflation was what cost him the election. If this is true than it may be that the man in the street is on a virtually instinctual level wholly opposed to the idea of inflation and can ever be made to see it in more complex multi-dimensional terms, which is what Noah Smith had in mind with his piece. Bob Murphy seems to think that the very attempt to do this is somehow arrogant. We should bow the the wisdom of the man on the street's instinctive antipathy for inflation-sort of like Kant's belief that those without knowledge of formal logic might be better moral arbiters of what's right.

      Interestingly, Nixon didn't think that the average person is so opposed to inflation. For him the debate about inflation was always in danger of being a merely abstract problem whereas a half a point jump in unemployment is "dynamite."

     Arguably Nixon felt this way as he lived in the shadow of first of all the Great Depression and more recently seeing the GOP suffer losses-particularly his own in 1960-due to insufficient stimulus from his own President, Dwight Eisenhower.

     Since then we had Carter's loss in 1980 and since then arguably there's been a lot more sensitivity to the idea that inflation is an election killer. With our current Lesser Depression this may again change some. At least price stability by itself may be less the whole rationale of policy going forward.

     Biven makes the interesting point that while inflation has bad effects, these effects tend to be exaggerated:

      "What's interesting is that the economy by many gauges performed quite well during Carter's term. Per capita GNP was very strong-strongest since LBJ. Carter along with LBJ, Reagan and Clinton alone among President's since 1964 had employment growth in excess of population growth."

         "Biven also points out that arguably inflation is not as socially destructive as it seems. To be sure it causes problems. Yet many had a pretty strong inflation hedge during the 70s-the steady rise in housing prices more than made up for the rise in the general price level. Inflation in fact may have a worse effect on the rich than low income people overall. (For these arguments see pg. 4."

          "It certainly helps borrowers vs. lenders and in general the first group is less wealthier than the second. Yet the public has a very negative view of inflation. On the one hand for everyone who is hurt by inflation someone else is benefited. Yet even those who benefited from 70s inflation viewed themselves as damaged."

           What really interests me is to be better able to quantify the effects of inflation-both positive and negative. My sense is that it's not an unmitigated evil-though surely not an unmitigated good-and that it may be the price of civilization. True inflation was much less common prior to the end of the gold standard. But just the same the level of technology and growth we've seen since then would not have been possible without a more high powered financial system.