Tyler Cowen has highlighted the need for better inflation models in several recent posts. In one case, he expressed outrage at my assertion that (price) inflation is a largely meaningless concept.
4b.More seriously, Scott seems to reject the concept of price levels altogether. For example, he once wrote: “I have frequently argued in the past that inflation is a largely meaningless and useless concept.” “I don’t even know of a consistent definition of this concept.” I don’t think this is a defensible point of view. One should compare Scott’s criticism of the o1 model with his own approach, which is quite nihilistic. And I think I’m wrong. If inflation rose further and someone approached Scott to sign an inflation-indexed contract, wouldn’t he be able to value such a deal?Obviously not.
Yes, “almost meaningless” is an exaggeration. But I think it’s far less of an exaggeration than most economists assume. I will introduce my case with an example and then discuss Keynes’ views on this subject. I believe this is more accurate than the views I have expressed previously and those of Tyler. Next, we will discuss the Chinese economy. In this field, I believe that price levels are important, whereas most other economists “completely reject the concept of price levels.” No one would be very good looking (except Keynes).
What led me to the overheated claim that inflation is largely meaningless? Why not take a peek inside the “sausage factory” to see what happens when governments estimate inflation? It would be helpful. For example, the more I look at official government estimates of TV inflation, the more skeptical I become about the whole process.
According to the U.S. Bureau of Labor Statistics, TV prices will be 99.15% lower in 2024 than they were in 1960 (a difference in value of $495.77).
From 1960 to 2024: Average annual television inflation rate was -7.18%. This rate of change indicates significant deflation. In other words, the equivalent purchase of a TV that cost $500 in 1960 will cost $4.23 in 2024. Compared to the overall inflation rate of 3.76% over the same period, television inflation was significantly lower.
To me, that estimate not only seems wrong, it seems bordering on the insane. That’s despite the fact that I’m probably in the top 1% of snobs who really care about image quality. A few years ago, I paid thousands of dollars for a 77-inch OLED TV. Yes, in a technical sense, modern sets are much better. But is it 100 times better? Please define the term “better”.
If you ask an economist, they’ll probably tell you that “better” means more utility. That’s all well and good, but what utility measuring device determined that viewers were getting 100 times more utility from modern television?In 1960, I was five years old. I don’t remember image quality having much of an impact on how much I laughed while watching “I Love Lucy.” What does it mean that modern television is 100 times better?
Economists are particular about whether CPI or PCE is closer to the “true rate of inflation.” But how can we know the true rate of inflation when economists can’t even precisely define what the word “better” means?
If TV were the only good thing, I would stand by my argument that government inflation forecasts are “mostly meaningless”. But that’s not the only good thing. And we have to admit that inflation predictions for a gallon of gas or a dozen eggs are far from meaningless. The overall CPI is a hodgepodge of composite data points, all mixed together with meaningless and meaningful data points.
Below is Keynes’ discussion of whether inflation data is meaningful in his General Theory.
However, the proper place for such things as net real output and the general price level is within the field of historical and statistical description, whose purpose is to satisfy historical or social curiosities; , our causal relationships, etc. require perfect precision. Analysis requires complete or accurate knowledge of the actual values of the quantities involved, but this is not usual or necessary. Net production is higher today than it was 10 years ago or even a year ago, but price levels are lower.Queen Victoria was a better queen, but she is not a happier woman. It is a proposition of the same nature as the assertion that it did not exist. Queen Elizabeth — This is a meaningless and uninteresting proposition, but it is inappropriate material for calculus. If we try to use such partially vague and non-quantitative concepts as the basis for quantitative analysis, precision becomes a false precision. . . .
Therefore, when dealing with employment theory, I propose to use only two basic units of quantity: the quantity of monetary value and the quantity of employment. . . . The unit for measuring the amount of employment is called the labor unit. We will call the monetary wage of a unit of labor a wage unit. . . .
I believe that when dealing with the workings of the entire economic system, we can avoid much unnecessary confusion if we limit ourselves strictly to two units: money and labor. The use of specific units of production or equipment is only used when analyzing the production of individual companies or industries separately. and the use of vague concepts such as total output, total amount of capital equipment, general price level, etc. when attempting to make historical comparisons within a certain range (perhaps quite wide). . ) limit is obviously imprecise and approximate.
In general, I think the general theory is highly overrated. Of course, Keynes was great, so there are some good points. But overall, this is a much less useful macroeconomic guide than the previous booklet on financial reform.
However, the above quote is a very insightful observation. Keynes was right. Vague concepts like price levels may be useful for some purposes, but they are inadequate for more rigorous scientific investigation. Also, while price inflation is of little use, wage inflation should be a central concept in macroeconomic models.
On the other hand, although inflation is a nebulous concept, it is clearly not an irrelevant observation that Venezuela’s nominal GDP growth rate overestimates its real GDP growth rate due to the rapid rise in the price level. We have some rough but reasonable estimates of price inflation that help clarify comparisons between periods or countries.
Consider my frequent claim that China is the world’s largest economy. This statement only makes sense when you substantively compare the US and Chinese economies. Nominally, the United States is the largest economic power. In that sense, I’m a bit of a hypocrite.
When Tyler says that I “completely reject the concept of price levels,” the reader might be forgiven for assuming that I hold some fringe views outside the mainstream. So I decided to Google “world’s second largest economy” to see what I could get. At the top of the list is an introduction to AI.
A long list of links followed that mentioned China rather than the United States (currently the second largest economy). Still, the claim that China is in second place only makes sense if you “completely ignore the concept of price level.” There are no reasonable estimates of the price levels in the United States and China that would place China in any position other than the world’s largest economy.
Now let’s compare Keynes’s views with those of mainstream economists.
1. Both Keynes and I believe that wage inflation and employment are two important macroeconomic variables. Price inflation is not completely useless, but when wage inflation is taken into account its marginal value becomes almost zero.
2. A recession occurs when aggregate demand falls relative to the nominal wage rate.
3. Price levels may be interesting for making very general comparisons about the relative sizes of economies, or for estimating changes in living standards over very long periods of time, but they are not as if they were an exact science. It should not be treated as if it were a concept.
4. The original Phillips curve wage used inflation. I’m almost certain that Keynes would have shared my view that the subsequent move toward price inflation was a mistake.
In summary, economists tend to use price inflation where it is inappropriate, where wage inflation would be much more useful. Worse, when precisely considering broad generalizations for which price level adjustments are quite appropriate, such as the question of whether the United States or China is the world’s largest economy, they They often completely ignore the concept of levels.
Also, when discussing “economy”, please don’t claim that AI Overview assumes you mean “nominal economy”. If you asked an AI about recent U.S. economic growth, I’m pretty sure it would cite real GDP data, not nominal GDP. That also applies to media. When we talk about the “economy,” we tend to refer to real GDP when discussing business cycles, but when we want to show off the superiority of the American economy, we suddenly refer to nominal GDP.
PS.As a side note, I would like to wish my father-in-law, Maxwell Freeman, a happy birthday to his 100th birthday today. Max fought during World War II in places like Leyte and Okinawa, earning two Purple Hearts. He is still doing well.
