Comments on: The Harvey files 1: inflation

By: m phelps

m phelps — Thu, 02 Aug 2007 10:24:27 +0000

The conventional way to approach this is to break the effects of an interest rate change into an income and substitution effect. The substitution effect will “always” be to reduce spending. The income effect is different for borrowers and lenders. For borrowers the income effect is negative (unless they switch to lending). For lenders the income effect is positive. The overall effect on aggregate income is zero, so the net overall income effect depends on whether there are differences in behaviour between borrowers and lenders in aggregate. But a rise in interest rates only decreases the income of borrowers by the same amount as it increases the income of lenders. Saying that a rise in interest rates results in higher incomes seems to me misleading at best.

By: Harvey Cole

Harvey Cole — Wed, 25 Jul 2007 15:01:39 +0000

Not so fast. Of course it is well known that people with savings have a lower propensity to spend. (But it also needs to be remembered that some determined spenders increase their borrowing when their purses are tight) the whole point is that the gross impact of higher interest rates on spending is offset to some extent by increases in spending power – which was my original point.

By: m phelps

m phelps — Fri, 20 Jul 2007 17:48:40 +0000

Even more confusion. Interest rates do not trigger higher spending power. A rise in interest rates raises the income of savers by the same amount as it reduces the income of borrowers - there is no net effect on income. The conventional wisdom is that savers have a lower marginal propensity to spend than borrowers, so a redistribution of income to savers will cause a fall in spending.

By: Harvey Cole

Harvey Cole — Tue, 17 Jul 2007 13:25:44 +0000

Calm down! Surely nobody thinks that prices actually cause an imbalance between supply and demand. They reflect them. Changes in the rate of price increases are of course significant but still a symptom rather than the cause. All I have pointed out is that reliance upon Edward Heath’s quote “single club” of interest rates is in fact double edged if they automatically trigger higher spending power too. That is why they are, in part, counter-productive and need to be supplemented by other measures.

By: Anaximander

Anaximander — Mon, 16 Jul 2007 13:58:36 +0000

By the way, I guess most parents would also disagree with B1. See also http://en.wikipedia.org/wiki/Fever. Fever is defined as “raised temperature”; of course it is usually a symptom of a disease or infection.

In addition, the analogy you draw between A3 and B3 is completely arbitrary and justified by essentially nothing at all.

By: m phelps

m phelps — Mon, 16 Jul 2007 10:07:13 +0000

Just to try and dispel the confusion. Most economists would have problems with A1. Inflation, let me repeat, is simply the RATE OF CHANGE of the price level. If we observe rising prices we know that inflation must be positive, but until we know how fast prices are rising we don’t know the inflation rate. But the rate of change of prices is inflation, not a symptom of inflation(at least if we stick to conventional definitions. And in any case the Bank of England is worrying about a rise in inflation ie prices going up faster than before.
And if we were going to have a serious discussion about these issues we ought to note that an oil price rise is a relative price change and will benefit oil producers at the expense of oil consumers whether the overall price level rises or falls. It is more like a tax on oil consumers (is that what Harvey meant to say?) with the proceeds distributed to oil producers.

By: GoodGrief

GoodGrief — Sat, 14 Jul 2007 09:46:27 +0000

PPE studies (just a guess??) do not a macroeconomist make. Your first point is not even wrong, HC. Fine, Interest rates do not impact all parts of an economy in the same direction, that’s obvious — but they are the best instrument we have. This is not a trivial point, otherwise I wouldn’t bother to reply. Anyone interested can read this: http://www.bankofengland.co.uk/monetarypolicy/how.htm

My biggest concern is the implication in the title that this is to be a series of ‘Harvey Files’. Please, no more.

By: m phelps

m phelps — Fri, 13 Jul 2007 18:00:23 +0000

Inflation is conventionally defined as the rate of change of the overall price level. We can agree that this is usually caused by aggregate exceeding aggregate supply. Does Harvey mean that inflation is a symptom of excess demand? If so fine. But to cure excess demand you generally need to cut aggregate demand and interest rate rises are a simple way of doing it.

By: Harvey Cole

Harvey Cole — Fri, 13 Jul 2007 15:30:51 +0000

Could your good but grievous correspondent consider descending from his pinnacle of polysyllabic use and let us know which of the following propositions he dissents from - and why.

A1 Rising prices are a symptom of inflation, and not inflation itself.
B1 Raised temperature is a symptom of fever, and not the fever itself.

A2 Rising prices are the natural reaction of an ecomony in an attempt to restore the balance between demand pressures and supply.

B2 A high temperature is the body’s natural attempt to restore equilibrium.

A3 Exclusive reliance on the blunt weapon of interest rates has some counter-productive consequences.

B3 Exclusive reliance on the sharp instruments of amputation is apt to result in overkill.

Raising interest rates in a kneejerk reaction to rising prices also aggravates the growth of incomes and expenditure - particularly when the ‘inflation target’ is based on a measure (CPI) which understates the rise in prices which more fully reflect living costs (RPI). Supplementary measures to curb the growth of income and expenditure are also needed, even though they may be politically unpalatable.

By: GoodGrief

GoodGrief — Thu, 12 Jul 2007 15:20:35 +0000

Good grief. If Prospect could hire someone who knew his Phillips curve from his Phillips screwdriver this might make a bit more sense. I don’t know why this piece started, what its point is, or how exactly it intends to illuminate readers. HC reads like a ‘Charlie Brooker’s Dictionary of Macroeconomics’. You mean that inflation is caused by excess demand, which is a bit like something getting bigger, which is a bit like ‘inflation’. How does that lexicographical quagmire help us? Please do economics properly. Or at least don’t pretend that you’re trying to and keep printing stuff by Ormerod.