Wednesday, 5 March 2014

Further confusion as to what inflation really is.

This morning I attended a generally excellent seminar hosted by Vanguard.  Vanguard are one of the foremost managers of index funds in the world. Their funds are useful and have very low costs.

The main speakers were Dr Peter Westaway Chief Economist Vanguard Europe and Dr John Velis, Senior Investment Analyst at Vanguard.  Dr Velis was presenting about fixed interest investment.  Overall both speakers were excellent and clearly seriously bright blokes.  Dr Westaway has Three Degrees.  His CV is here https://www.vanguard.co.uk/documents/portal/press_releases/peter-westaway-appointment.pdf

However, or rather, as ever, these people remain very confused as to what 'inflation' actually is.

In his presentation Dr Westaway seemed to say that inflation was the rise in prices, that is the RPI was inflation.

In his presentation, or rather in the questions, Dr Velis said that the increase in the price of equities could be attributed to inflation - as in the expansion of the money supply.  Or rather that equities exhibited some automatic inflation hedging qualities.

So, either inflation is a function of money or it is a function of prices.  I asked Dr Westaway this question and he insisted that inflation was the rise in prices, and qualified that by remarking that "anyway since we had not had much rise in prices then the expansion of the supply of money was not causing 'inflation'".  At this point we were interrupted. 

In any event in my view there have been considerable price rises - notably in land, commodities and financial assets, especially equities.  Furthermore increases in the money supply take time to work through an economy (the pouring treacle analogy) and we may not yet see the effect generally.

I have increasingly noticed the circular arguments used by mainstream economists when talking about what inflation actually is.  Have you?

Discuss.

48 comments:

Mark Wadsworth said...

It's all made up numbers.

The amount of "money" sloshing around all depends on how you define "money", because if you include ALL debts and ALL credits there is precisely zero money.

So you have to narrow it down to a certain defined list of either debits or credits which you think is meaningful.

Asset prices are of course the flip side of credit availability and interest rates, but do rising asset prices (bubbles) cause credit expansion; or does credit expansion cause asset price rises, or is a bit of both?

I preferred your old categorisation of "monetary inflation" and "tax induced inflation".

And so on.

Lola said...

MW - I was about to set off on the 'the total sum of money in the world is zero' meme, but truthfully? I just was losing the will to live..

Dinero said...

At the fundamental level the money supply concept is a myth.
If it were real then it would be possible for banks to run out of money , which of course they can't.
The amount of money in circulation is down to what bank customers want in debt. Banks don't lend something - they monetise mortgages and other IOU instruments. What matters is the interest rate.
As for inflation, from a monetary perspective, it is what effect purchasing decisions have on prices. So inflation is a change in prices.

Derek said...

Lola, you're absolutely right about this widespread confusion between rising prices and inflation. It annoys me too. They are two different things.

The way I look at it, prices are set by the interplay of one set of supply and demand forces acting on goods and services and a second set of supply and demand forces acting on money. As a result there are four possible causes for rising prices:
a) a rise in the demand for goods and services;
b) a fall in the supply of goods and services;
c) a rise in the supply of money;
d) a fall in the demand for money.

... and of course any combination of those four causes.

However only (c) is truly inflationary in that the amount of money changes. Rising prices due to (a) can be signs of a bubble or of changes in technology; those due to (b) are a sign of increasing poverty or changes in technology; and those due to (d) can be signs of increasing economic independence or decreasing levels of debt.

Naturally these things only happen in combination, so for instance the Zimbabwe inflation was initially caused by (b) which then led to the politicians trying to fix it with (c) -- to no avail -- so the overall picture can get pretty complex. However I suppose that this is why people generally oversimplify and just say that any rise in prices is inflation.

Derek said...

Dinero, I agree with what you say in principle. However in practice there are other factors which affect the supply of money by banks like their lending rules or their customers willingness to borrow. This means that at some times it is easy for bank customers to take on debt while at others it is very difficult; at some times it is easy for banks to lend while at others it is more difficult.

In practice this has a big effect on the supply of endogenous money.

Lola said...

Dinero, what about what Derek says?

Dinero said...

Well that comes down to the interest rate.

If we go on from the fundamental level You can say for people that are not willing to take on debt there is a "money supply" that is created by the debtors, which can be obtained by selling things.

There are other complications , High interest rates can be infationary if they reduce productivity and reduce supply.

Even supply and demand is not simple.

For example reduced demand can increase prices as the unit cost of mass produced goods goes up with less demand and less production.

Dinero said...
This comment has been removed by the author.
Dinero said...

As for lending rules

in the UK banking system a requirement for reserves is not mandated.

Bank of England

" The reserves scheme is voluntary....."


and

" Participation in the reserves-averaging scheme
is voluntary other than for CHAPS(7)sterling andCREST
(8)sterling settlement banks, which join the
scheme automatically because their role in the
payments system entails their having accounts, and
so maintaining balances, with the Bank. The level of
reserves targeted (up to the ceilings set by the Bank)
is also a choice for individual scheme members, made
monthly ahead of each reserves maintenance period."

Bankof England Website "explanatory notes wholesale" and "May 2006
Bank of England
The Framework for the
Bank of England’s Operationslend reserv
in the Sterling Money Markets"

Derek said...

Not quite the lending rules I meant. I was talking about the ones which the banks issue to their loan managers saying, "Do not lend to anyone with investments of less than £1,000,000 and two paid-off houses" when times are bad, or "If the borrower has (or recently had) a pulse, give him as much cash as he wants" when times are good.

Dinero said...

Right

So I think we agree that the money supply or loanable funds concept is a myth - it comes down to the sentiment on behalf of the bank loan manager and the customer

Derek said...

Absolutely.

Dinero said...

Cheers

Bayard said...

I tend to have a simplistic view of inflation as the general reduction of the buying power of the currency reflected in rises in both prices and wages. That's what I think it is, what causes it, I'll leave to the economists, but given that "money" is simply historic debt, if you increase the number of tokens measuring that debt (the currency) without increasing the debt, then the amount of debt each token represents has got to fall. Otherwise it's like changing from Centigrade to Fahrenheit and claiming the temperature has gone up.

Lola said...

Bayard - the Centigrade / Fahrenheit / which is hotter or colder analogy is the one that I often use.

Dinero said...

The prices of things that in quantity are not effected by demand and are purchased directly with debt are the ones that are most likely to be effected by banking conditions

Dinero said...

> Lola

I remember that Vanguard announced Vanguard UK in Forbes magazine a few years ago - how are they doing are they having good returns

Mark Wadsworth said...

Din: "The prices of things that in quantity are not affected by demand and are purchased directly with debt are the ones that are most likely to be effected by banking conditions."

Yes, exactly.

And those things are usually monopolies, so we can work backwards and say that if the value of something is affected unduly by interest rates, it is probably a monopoly (mainly land but also shares and bonds).

The price of food or cars, or the level of wages is barely affected by interest rates, why would they be? And those things aren't monopolies.

Lola said...

Dinero

Vanguard are an index manager. Their returns are therefore, or should be, the returns of the index they are tracking - e.g. FTSE UK All Share - less costs.
They are a 'good' index manager and their funds are very keenly priced, so yes, they do have 'good' returns for their investors.
You can try and achieve a return greater than say the FTSE UK All Share by tilting to a higher proportion of holdings in small companies or 'value' companies.

Dinero said...
This comment has been removed by the author.
Dinero said...

> Lola

Thanks

Dinero said...

> Mark

Yeh,

the epitome of non monopoly pricing - cans of baked beans

Lola said...

Dinero - yet baked beans, and more transparently, the price of butter has risen quite markedly since ooooo about 2007. Why? I can't see that that is down to supply issues, or demand issues.

Lola said...

Found this...
https://www.gov.uk/government/publications/agricultural-price-indices
These prices have risen by quite a lot. But why? I am considering that farming is getting more efficient all the time. Bread is basically sunshine and diesel. From memory it takes 6 or 8 passes by a tractor and one by a combine to get cereals from a field to the mill. The main input price increase is fuel...
There is definitely something going on here independent of stuff. I think, think, it is the destruction of the value of money

Dinero said...

Have you got any stats for those two prices , I have not seen it, quite the oppositie , cut price kidney beans are the new thing

are you still thinking about the money supply concept

that can not be right because the peolple buying those things are not promoting the price with easy money if those things are becoming more towards the unaffordable, that would be a contradiction

Mark Wadsworth said...

Yes, of course food prices have gone up quite markedly over the past few years, this is a combination of
a) a rise in the demand for food;
and/or general price inflation caused by
c) a rise in the supply of money;
and/or possibly poor harvests.

However, I was talking more specifically about the effect of INTEREST RATE CHANGES on the prices of things.

I cannot see how changes in interest rates affect car, food etc prices. Interest rates went up in the early 1990s and house and share prices went down, but car and food prices did not go down to match, did they?

Ralph Musgrave said...

The generally accepted definition of "inflation" changed about 30 years ago. If you look in a dictionary published before approximately that date, it will define inflation as an increase in the money supply. After approximately that date, the definition changes to "increase in prices".

DBC Reed said...

If inflation is caused by more demand than the supply of goods then the supply side is an issue.Rent seeking, particularly with land, is going to restrict supply putting up prices in that sector.So, as MW says, monopoly and the mother of all monopolies,looms large.

Lola said...

MW. I think, but do not know, that interest rates are independent of inflation, although setting rates too low encourages expansion of credit and reduction in savings and viky verky. The government money monopoly could encourage the expansion of money and credit (in fact that seems to be what they are banging on about now). Which is probably a further confusion between 'credit creation' and 'lending'. The former being 'inflationary' under the current FRB model and rules, the other not being so, if funded by deposits - not as under the current rules.
Also the current FRB rules are not market rules but arbitrary bureaucratic central planners rules. They are too weak. My guess is that market FRB rules would require much high ratios.
It's all a conundrum, but I am going to hold to my (Misean?) 'inflation is the unwarranted expansion of money and credit' definition - however it comes about.

Lola said...

DBCR - That looks like the Keynsian demand pull / supply push inflation thingy. I do not think that is correct since in either of those two cases markets will adjust to change prices to their market clearing level. In other words these are short term price changes phenomena.

Lola said...

DBRC - to expand. I agree about the land rent monopoly bit, though. Although pumping more funny money into the economy plus all sorts of subsidies for land ownership does do a lot to drive up prices. Without the unwarrented expansion of money and credit would the super profits from land be, well, so super?

DBC Reed said...

I have always been of the opinion (none too popular amongst fellow land taxers) that LVT should merely hold the land price level steady, while the economy is deluged with cheap money in a reckless manner.I am not too fussy
where the money comes from: FRB at low interest rates; Quantitative Easing for the People (supported by big name Economists) ; government spending in excess of any tax or borrowing receipts; Social Credit (only supported by old loonies who happen to be right): Gesellian velocity money which cannot be saved and has to be spent in shops before it evaporates (see Chiemgauer).Doesn't matter which.Just has to have LVT as a back stop to stop cheap money disappearing into land and property (as now).Not much to ask for is it? You'd think so.But oh no !

Dinero said...

Restricting banking activity to lending deposits would have the net effect of raising interest rates and so the concept is inconsequential as with credit creation as it is the central bank can allready target higher interest rates for credit if it considers it necessary to stop inflation.

Lola said...

D. Yep. But I did say the 'current model' of FRB. FRB would still happen, but the R bit would be decided by the market, not bloody useless bureaucrats. (if that is a response to your last post?)

Dinero said...

as for the UK, Fractional Reserve Banking is a myth.
They are not a requirement.

Don't beleive it ? see this link

" The reserves scheme is voluntary....."

Bankof England Website "explanatory notes wholesale"

Lola said...

D - no link?

Dinero said...

Google search on - Bank of England Website explanatory notes wholesale

DBC Reed said...

@D
What are you saying: that the banks don't have to keep even fractional reserves? That we have No Reserve Bbanking? All the lending is of new money made up on the spot and not borrowed off existing bank customers? Best be clear about this!

Dinero said...

Yes that is the case. Banks do not have to have any reserves to facilitate a loan. What they need is a quality bond, mortgage etc.

The bond is the primary thing of value in the system, and the goods and services sold to pay it off, the deposit is an accounting tool indicating who is the beneficiary to that value.



DBC Reed said...

@D It might help if you analysed the Basel 111 proposals (they're not implemented yet are they?)using your criteria.

Dinero said...

There are reserve requirements in the USA.
There are no reserve requirements for the UK and other examples where there are no reserve requirements are Canada and Australia .


What about Basel 111 are you picking out. I had a quick look and saw nothing about reserves therein.

Dinero said...

capital requirement, liquidity requirement and levarage ratio are different ways of comparing the assets to the liabilaties.

Lola said...

DBCR and D - and the world wonders why the banks are screwed. It also proves my basic position that all regulators are clueless.

Dinero said...

What suprised me, reading the Bank of England website, is that it is not a requirement for a bank to have a reserve account with the Bank of England.

DBC Reed said...

@D
The language used for Basel 111 is vague to say the least. Talking from memory, there is mention of decreasing leverage and increasing liquidity ,Tier I capital (banking shares, retained profits etc)and percentages are given for optimum leverage ratios. But does Basel 111 specify a minimum fractional reserve (of deposits)?Or is No Reserve Banking the order of the day?

Dinero said...
This comment has been removed by the author.
Dinero said...
This comment has been removed by the author.
Dinero said...

Basel 111 is an international regime. Reserve ratio requirements are National. They apply in the USA , they are not a requirement in for example the UK, Australia and Canada.