Peter Franklin

Peter Franklin is Associate Editor of UnHerd. He was previously a policy advisor and speechwriter on environmental and social issues.


Today, I’m UnPacking an article by Michael Lebowitz and Lance Roberts for Real Investment Advice (also available on ZeroHedge); but it’s an argument within the argument that I’m really interested in.

The overall thrust of the piece is a critique of Modern Monetary Theory (MMT) – an ‘alternative’ school of economics currently in favour with American Left-wingers like Alexandria Ocasio-Cortez.

The authors quote Kevin Muir‘s definition of MMT:

“Modern Monetary Theory is a macroeconomic theory that contends that a country that operates with a sovereign currency has a degree of freedom in their fiscal and monetary policy which means government spending is never revenue constrained, but rather only limited by inflation.”

In other words, if you’re in a position to make your own money, you don’t need to worry about budgetary deficits or public debt, you only need to worry about prices. Given that inflation has been low for a generation and continues to stay low despite the return to growth and near full employment, government can afford to fund lavish spending programmes like the proposed ‘Green New Deal’.

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But what if inflation is much higher that we’ve been led to believe?

Writing from an US perspective, Lebowitz and Roberts argue that we’ve been misled:

“…during the Clinton Administration, the Boskin Commission was brought in to recalculate how inflation was measured. Their objective was simple – lower the rate of inflation to reduce the amount of money being paid out in Social Security.

“Since then, inflation measures have been tortured, mangled, and abused to the point where it scarcely equates to the inflation that consumers deal with in reality.”

Here’s an example:

“…home prices were substituted for ‘homeowners equivalent rent,’ which was falling at the time, and lowered inflationary pressures, despite rising house prices.

“Since 1998, homeowners equivalent rent has risen 72% while house prices, as measured by the Shiller U.S. National Home Price Index has almost doubled the rate at 136%. Needless to say, house prices which currently comprise almost 25% of CPI has been grossly under-accounted for.”

‘Homeowners equivalent rent’ is a specific case of ‘imputed rent’ – which is what you’d have to pay for the use of your house or car if you didn’t own it (or, to put it another way, what you could earn by renting it to someone else). It’s a theoretically ‘pure’ and consistent way of assessing the value of assets, the sort of measurement that appeals to economists. In the real world, however, most people who buy a home don’t care about its imputed rent, but what they actually have to pay for it – which, surely is the only kind of price that matters.

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This is not the only way in which the official inflation rate depends on theory rather than straightforward observation:

“There is also a measure called ‘hedonics’ which is used to account for the change of value of a particular good over time… an example [is the] additional power of modern computers [which] means consumers are getting more for their money than in prior years, hence paying less according to inflation calculations.

“Some hedonics make sense, like computers, but many do not. Can you apply the same logic to High-Def TVs? Unlike the computer, TV’s serve no economic benefit. Should inflation measures be reduced because you now have a 50-inch flat screen versus a 32-inch one? We say no.”

This is quite the rabbit hole. Take the example of cars: at any particular price point, these are more reliable and fuel efficient than they used to be. On the other hand, congestion means that driving is a much less rewarding experience than in the age of the open road. Or food: on the one hand it’s great that we can have fresh tomatoes all the year round, but on the other hand they don’t taste of anything.

How on Earth does one adjust for the positive and negative ‘hedonics’ of all of that? Depending on the value judgement one makes we could be much richer or much poorer than we’re officially purported to be.

The problem of subjectivity also applies to ‘the basket of goods’ use for the inflation calculation. Adjustments to the content are required from time to time (to take a trivial example, the price of lard is not as relevant today as it was a hundred years ago). But while genuine shifts in consumer preference should be reflected, other consumer trends could be distorting the picture. A shift in spending to some classes of increasingly affordable goods and services (e.g. electronic gadgets) may reflect an attempt to compensate for the fact that other, more important, items such as decent and conveniently located living space, are getting more expensive.

And whose experience of inflation are we talking about anyway? If, say, luxuries are getting cheaper while everyday necessities like rent, utility bills and childcare are getting more expensive, then averaging it all out conceals the fact that most people whose outgoings are dominated by the essentials are experiencing a higher rate of inflation than those with money to burn. (There’s a parallel here to GDP figures – if most of the proceeds of overall growth are going to the rich, then the rest of us are experiencing a stagnant economy not a growing one.)

So, inflation is a slippery concept. And what’s more, governments have every reason to use this lubrication to massage the figures down. The lower the official inflation rate, the lower the expenditure on index-linked payments like state pensions – and the higher the rate of ‘real’ economic growth.

Mainstream economists have every reason to go along with the official line, because it appears to validate the mainstream monetary policies of the neoliberal era. Left-wing economic theorists also have a reason not to rock the boat, because their borrow-and-spend policy ambitions depend on inflation not being a problem. Then there’s a huge commercial vested interest – comprised of all of all of those businesses whose speculations depend on an inexhaustible supply of cheap credit.

Of course, those who claim that the real inflation rate is much higher than everyone else admits can be written off as a fringe – in the same category as ‘goldbugs’, crypto currency enthusiasts and other heretics.

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But try this thought experiment: If there were an economy in which inflation definitely had been under-reported over a long period, what would it look like?

One might expect increasing levels of dissatisfaction among ordinary working people who don’t feel as rich as they’re told they are. Other likely symptoms might include: a long-term build-up of consumer and public sector debt in order to finance ‘normal’ levels of spending; the inflation of speculative asset bubbles; puzzling shortfalls in genuine productivity; a destabilising accumulation of bad risks in the financial system; and the collapse of public trust in conventional politics.

Remind you of anything?