Why The Central Bankers' 2% Inflation Standard Doesn't Compute

By Brendan Brown at Mises Institute

In our time, the greatest source of money chaos is now the global 2%-inflation standard. Deflation-phobic central bankers, led by the FOMC at the Fed, are defying the natural rhythm of prices in a capitalist economy. Under sound money, there would be periods of both falling and rising prices.

Since central bankers choose to steadfastly ignore this reality, the result has been the emergence of three serious global asset price inflation diseases in just three decades. Their undermining of economic prosperity has shown up as a situation marked by low investment, malinvestment, and correspondingly weak real income and productivity growth. This has been coupled with episodes of huge profits for “Wall Street,” and the resulting increased inequality has made fertile ground for populism both on the left and the right. Meanwhile, the intensified regulatory state, which populism has helped produce, has compounded the economic malaise.

The Role of “Official” Productivity and Inflation

A principal tenet relied upon by the architects and advocates of the global 2% inflation standard has been that productivity growth is greater than is reported, while inflation is less than reported — according to the official statistics. And so, 2% inflation on the official measure might be only 0-0.5% in reality.

Meanwhile, the central bankers claim, statisticians are not correctly measuring the improvements in our daily lives that new technology brings. Price measurements, we’re told, don’t tell us enough about how much value is added by innovative products, such as time saved, or safety gained. The effort to include these improvements within the price measures is known as hedonic price accounting. Hedonics is designed to measure the fact that automobiles technology, for example, makes cars safer and more comfortable than you think. Yes, cars are much more expensive today — the argument goes — but we have to factor increases in quality and efficiency into modern prices. If you take this into account, the central bankers claim, then inflation is actually lower than you think, because the products we buy are all of higher quality now, and we’re getting more for our money.

Thus, if a piece of medical software does more today than 20 years ago, then inflation in the price of that good is actually less than the statistics suggest.

This Is Nothing New

The same point concerning price statistics could have been raised in the gold standard years of say 1870–1914, or in the 1920s, or the 1950s and 60s.

During those periods, incidentally, there was no hedonic price accounting then at all — so stable prices as measured by the available statistics would have been equivalent to say 1–2% “deflation” under today’s measurement techniques.

The transition from canals to railroad transportation — or from ice cupboards and salting to refrigeration — evidently had benefits which transcended crude price gathering by statistical offices.

Technological Innovation Has Both Costs and Benefits

Broader economic reflection suggests that the statisticians in the pre-hedonic price adjustment age — which began in the 1980s and was cheered on by Alan Greenspan — had it right. There are definite offsets to these quality improvements, some continuous and some discontinuous. The latter include the episodes of vast human and material destruction made possible by the new technologies.

For example, we can all recognize the ill consequences of the IT revolution which should be debited from the so-called productivity bonus. These include the cost of internet security — anti-hacking and anti-viruses in particular. While this is in fact a new burden, this new industry of security is treated by the statisticians as anaddition to economic output. There is also the empowerment of big brother and the potential dangers of cyberwarfare including horrendous knock-outs to electrical infrastructure.

There is nothing new in this. The development of the automobile went along with the need for road safety in terms of policing and infrastructure. Automobiles also brought a demand for increasingly sophisticated safety systems installed in the automobile itself. And then there is the whole deadweight cost associated with the accident insurance industry. There has always been the parallel horror of what might happen when the new technologies enter actual military warfare.

The experimenters at the modern central banks who have been operating the global 2% inflation standard argue today is different, and technological innovation is always a net gain.

Populists, however, recognize that, in spite of new technologies popping up constantly, all is not well. Some of the populists who recognize a problem of monetary failure claim the solution is to change the party label of the central bank’s chair. Donald Trump, for example, suggests he would replace Yellen because she is not a Republican. But wasn’t Bernanke a Republican?

Others (on the left) would add racial or gender diversity to the Fed board and intensify regulation.

Not surprisingly — given what we know about American politics — the real solution is not on offer: an exit from the 2%-inflation standard and a transition to sound money.

The Populist Threat to Sound Money Endures

There is no inevitable path from monetary chaos to any particular frightening political outcome — including Robert Kagan’s nightmare prediction that “Trumpism” is “how fascism will come to America.”

Trump is only a symptom of a far larger problem. The economic conditions that have paved the way for “Trumpism” are really a result of decades of monetary disorder brought to us by central banks.

In the 18th century, British economist John Stuart Mill wrote “most of the time the machinery of money is unimportant but when it gets out of control it becomes the monkey wrench in all the other machinery of the economy.” There should have been a second sentence about how the dysfunction of the invisible hands attributable to the monetary disorder endangers political liberalism.

Source: Central Bankers Claim: Things are Better than You Think - Mises Institute

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