Misunderstanding Inflation

Monetary inflation leads to inflation in goods, services, and/or assets.  We just went through a decade (and then some) where there was low product price inflation, but there was significant inflation in asset values.

What was the response from policymakers?  Aside from a rare comment regarding “irrational exuberence,” most of the time they were fat, dumb, and happy.  Because of their flawed model for understanding monetary policy, they ignored asset inflation, and patted themselves on the back for the lack of goods price inflation.  What little attention they paid was through the weak construct called the “wealth effect.”

Make no mistake — printing money leads to inflation; the question is where the inflation goes.  The loose monetary policy of the last 20 years has definitely fueled an inflation of real estate asset values above that which is sustainable in the long run.

As such, I have little agreement with the following articles:

We have been through a unique era where monetary has had significant effect on the asset markets, but little effect on the goods markets.  Perhaps those effects were affected by demographics, and might change in the future.  Just because good price inflation has been weak in the past, does not mean it will be weak in the future.

Monetary inflation — an increase in the money stock or credit, will have an impact on asset and/or goods prices.  Which gets affected depends on the proclivity to spend versus save.

There is real reason to be concerned about inflation, then.  We face either:

  • an unsustainable increase in asset values, or
  • goods and product price inflation.

The former looks for likely for now, but who can tell?  As Baby Boomers tip the balance between saving and spending, goods and services inflation may predominate over asset inflation.

On the “positive” side, some of the troubles of asset inflation get passed on to credulous foreigners because the dollar is the world’s reserve currency.  That weakens the feedback effects in the short run.

My main point is this: there is no free lunch.  Either money buys less, or assets buy less because of monetary inflation.