Archive for June 17th, 2010

Meeting John Global….a global citizen in 2026…

June 17, 2010
Krzysztof Rybiński, earlier Deputy President of the National Bank of Poland has this fascinating lecture on the topic. 

He talks about John Global, a Pole who becomes a global citizen after 20 years and what his lifestyle would be. As the lecture is given in 2006 he forecasts the lifestyle in 20 years.  


Why do economists and ordinary people differ on the costs of inflation?

June 17, 2010

I thought there is a general agreement in public that costs of inflation are huge. However, empirically this is not the case and economists differ on the costs.

Yi Wen of St Louis Fed writes an exciting note on the same:

Economists have often puzzled over the costs of inflation. Di Tella, MacCulloch, and Oswald (2001) present cross-country survey evidence that people’s happiness or life satisfaction is adversely related to their country’s inflation rate. Also, survey evidence presented by Shiller (1997) shows that people from all walks of life dislike inflation because they almost unanimously think that inflation erodes their standard of living.

Yet standard economic theory predicts that the costs of inflation are small. The argument is that nominal income can adjust for anticipated inflation, leaving people almost as well off as they would have been in the absence of inflation except for the opportunity cost of holding non-interestbearing cash. Hence, economists commonly measure the cost of inflation as the area under the money demand function, which reflects the deadweight loss of holding cash instead of interest-bearing assets.

By this measure, inflation has surprisingly small costs: about 0.1 to 0.8 percent of consumption when the inflation rate is 10 percent per year. The result is robust regardless of whether aggregate data or household data are used to estimate the demand function of money (see, e.g., Attanasio, Guiso, and Jappelli, 2002).

Hmm. And why do they differ? Li points this could be because of two things – one economists don’t measure it properly. Two, people are myopic not to see the benefits of inflation as well.

Wen (2010) argues that the standard economic measure of the costs of inflation does not take into account the insurance (buffer-stock) function of money. Since inflation destroys the value of money and reduces the demand for cash, it exposes people (especially low-income households) to more consumption variability than otherwise. Based on  this concept, Wen finds that the cost of 10 percent annual inflation is equivalent to the loss of 8 to 12 percent of consumption (or income).

Excellent stuff. And why does public not understand the benefits of inflation? The author points public does not understand the causes of inflation. So say inflation is because of government spending on certain programs. The public may not see how government expenditure will help them. So inflation is kind of a tax via which government reduces its debt levels. Economists in turn calculate costs of inflation be comparing this inflation tax with a normal tax that raises revenues. Such analysis reduces the impact of inflation on public. 

Summary is:

Thus, according to the theory of myopic behavior, when trying to understand the costs of inflation, people may miss not only the connection between inflation and increases in nominal income but also the connection between inflation and the benefits gained from government spending programs. So, the reason why people dislike inflation is similar to why they dislike income taxation.

Fantastic really.

Assorted Links

June 17, 2010
  • This one takes the cake. Krugman says he is mild and softspoken comapred to Adam Posen 🙂
  • JRV says Indian regulators need to develop expertise in real time tracking of financial markets. He says:

Many observers in India (including some of the exchanges themselves) have been concerned about this transformation, but this is a global phenomenon and it is delusional to deny this reality. Concomitantly, there has been a blurring of the line between exchanges and brokers.

I don’t agree to this line of reasoning. Just because it is becoming a global reality doesn’t mean it is right and has to be accepted. Lot in ecnomics and finance was being accepted because of the same reason – it is global reality. Infact we need to ask more questions as it is becoming a global reality

  • Gulzar summarises the debate on whether there is a need for fiscal austerity right now. As usual Gulzar provides a linkfest.
  • Cowen points to measures NZ took in 1991 to lower deficit. The measures led to higher growth. Krugman responds to the new fancy – examples of how foreign countries grew despite cutting deficits
  • All links in WSJ Blog are a good read
  • Peston says George Osborne gave the most important speech the City has heard since Gordon Brown’s debut in 1997.

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