Great Expectations

The Chris Cook Economics 3.0 column

A piece of research by Goldman Sachs which I came across in the Financial Times Alphaville “walled garden” today had much to say on the subject of consumers’ fear of inflation and discussed whether or not this could itself drive inflation. One assumption was:

“Suppose every firm and consumer in the economy woke up one morning to expect 5% inflation”

and one conclusion was:

“A shift up in household inflation expectations could ignite a broad-based surge in inflation, but we see no sign that this is under way”.

This reminded me of my long standing conviction – from my admittedly untutored perspective of Coarse Economics – that such inflationary expectations are yet another example of an assumption which is complete bollocks but which conveniently justifies the otherwise unjustifiable.

Now one of the key reasons for the property bubble was the completely pervasive view that house prices can only ever go up. So it has demonstrably been the case that the average punter has inflationary expectations in respect of land prices (since buildings depreciate). By definition, inflationary expectations underpin all asset bubbles, which have with few, if any, exceptions been driven since John Law’s Mississippi Bubble by excessive creation of credit by credit intermediaries aka banks.

But retail prices are another matter altogether. The people who inhabit the real world outside neoclassical economics do not tend to think:

“Hmmm…..I expect that retail prices will rise by 5% in the next year, therefore I will ask for a 5% pay increase plus a bit.”

They think

“Bloody hell, prices have gone up 5% and I need a pay rise to keep pace, plus a bit”.

In other words, if prices do not rise much – or even fall, and of course deflation would be a wonderful thing if only our money did not consist of interest-bearing debt – then there would be little or no pressure for much more than modest wage increases. But we have drummed into us that employees/consumers do not think this way.

The inflationary expectations of employees could lead to inflationary wage increases, and must therefore be beaten out of them at all costs.

But then on Planet Neoclassical there is never a good time for wages to increase. In a growing economy, wage increases may choke off growth; in a level economy, wage increases will prevent growth; and in a recession of course, wage increases are unthinkable, because they will make the recession worse.

Bollocks again. Capitalists like Henry Ford knew that if he paid his workers poorly then they could never afford his cars. That piece of economic common sense appears to have been forgotten.

I have never understood why it is that to increase wage costs is inflationary; whereas to increase interest rates from 2% to 3% (which is a 50% increase in a financial cost) is not only not inflationary of retail prices but is in fact, the Voodoo Economics cure for such inflation.

It gets worse, though.

If a manufacturer raises prices either because he has the “pricing power” to do so (through a monopoly or cartel) – or simply because he is able to maintain an arbitrary profit margin – then such price increases are by definition inflationary. Well, actually in the fantasy world of Neoclassical Economics such maintenance or increase of the return to Capital is apparently not inflationary, although increasing the return to Labour is.

Strange, that.

In case you hadn’t gathered, conventional Economics has nothing whatever to do with the real world we inhabit and everything to do with justifying an outcome convenient for the owners of financial capital.

As JK Galbraith memorably put it:

“Modern conservatives engage in one of man’s oldest exercises in moral philosophy: the search for a superior moral justification for selfishness”.