Inflation and Policy


Inflation and Fiscal Policy

I was asked: Whatever Happened to Inflation after all this Money-Printing?


Raising inflation was not something that worried economists.

“Yet, today, even as central banks lower policy rates close to zero (or below) and expand their balance sheets beyond what anyone previously imagined possible, inflation remains stubbornly below target in most of the advanced world.”


The problem is most profound in Japan, where inflation doomed even with  BOJ’s 1/3 GDP balance sheet and NIRP.


“Aggressive monetary policies have worked even in periods when riskless interest rates were close to zero, private risk premia were elevated, banks were fragile, and burdensome debt overhangs were pervasive.” – the Great Depression


The stunning shift in the U.S. monetary and prudential regime that included the combination ofabandoning the Gold Standard and buttressing the fragile banking system triggered this sudden reversal.

-> it sharply altered expectations virtually overnight, changing the behavior of households, firms and banks in short order.

It looks like the most important thing is expectation.

(although the role of fiscal policy since 1933 is still arguable [1])

Back to Japan’s case,

Commonly-held view is that policy stimulus in the advanced economies ought to include a substantial expansionary fiscal component that has generally been lacking.

<- Abe has overseen a large fiscal tightening:

1. current IMF estimates show Japan’s structural fiscal deficit shrinking by 3.7% of potential GDP over the past three years
2. Cashin and Unayama estimate that, upon announcement of Abe’s tax plans in October 2013, households reduced consumption by 5.2%.
3. restoring debt sustainability will require a large fiscal tightening (Hoshi and Ito (2012)).


Why a fiscal policy is so important?

Christopher Sims argues that monetary expansion will not succeed in driving up inflation if “low interest rates fail to generate substantial fiscal expansion.”

<- According to this fiscal theory of the price level (FTPL), at low interest rates, stabilizing inflation requires a modicum of fiscal-monetary cooperation: the fiscal policymaker must be seen as willing to run an easier future policy that is consistent with higher inflation.

<- “If in the face of low inflation the central bank lowers interest rates, demand increases and inflation rises only if the reduced interest expense component of the budget is expected eventually to flow through to a reduced primary surplus.… There is no automatic stabilizing mechanism to bring the economy back to target inflation and stay there, unless the commitment to true fiscal expansion at very low interest rates is widely understood.”

So it seems Abe’s policy failed because he did not offer expectation.

“Put differently, today’s price level is jointly determined by monetary and fiscal policy. And, it is not just today’s policies that matters, but the entire path into the distant future.”


But, wait! We once read articles that told us Japan’s Fiscal Stimulus Won’t Work.

The economy is already at full employment!

<- Fiscal stimulus relies crucially on having those unemployed and unused real resources sitting around.

But maybe fiscal policy can do something with the high cash holding of Japan’s firms.


Wolf Richter has some different idea about why all this central-bank “money-printing” along with 0/NIRP haven’t caused a big bout of inflation, which actually supports the fiscal policy idea.


Yes central banks have heaped on their balance sheets, but the inflation caused by QE is not consumer price inflation, but rampant asset price inflation.

And the reason is because the money never went to consumers – in form of wages.

“Because the money has been channeled to big financial and corporate entities, and they plowed it into financial and other assets (including share buybacks and other forms of “financial engineering”), thus pushing up asset prices.These already wealthy people didn’t need to spend their gains (what Bernanke called the “wealth effect”) because they already were spending all they wanted to spend. So the asset price boom had little impact on consumption and thus didn’t create inflationary pressures from consumers.”

QE and ZIRP put a priority on capital rather than labor.

-> So inflation-adjusted wages for the lower 80% of households have declined, a trend that started after the real-wage peak in 2000, and accelerated with the Financial Crisis.



And QE and 0/NIRP also “search for yield”, which floods entire and very risky sectors with huge amounts of money -> “malinvestment”

-> which causes overproduction and gluts, such as in ocean container shipping, US oil & gas, mining & metals, other commodities, even ghost cities in China

-> which cause prices to collapse, filtering into consumer prices and pushes down consumer price inflation



Economic historians argue that fiscal policy played only a secondary role in lifting the U.S. economy during the 1930s (see, for example, DeLong and Romer). Importantly, this assessment is notbecause fiscal policy doesn’t matter, but because discretionary fiscal stimulus was so limited and desultory until World War II. Eggertsson contends that fiscal expansion in 1933 gave credibility to the stated objective of raising prices. But, as was the case in 1937 with the first round of Social Security contributions. at times, fiscal policy turned quite contractionary.


Inflation shouldn’t be Worried


The stuff we really need is getting more expensive. Other stuff is getting cheaper.

Why slightly higher inflation might benefit the U.S. economy

Overcoming Our Inordinate Fear of Inflation


Fixing America’s Roads Is a Great Opportunity


1. The conception of inflation itself may deserve a revision.

(Although eating and housing are still the most important parts for common life, so does smart phone in 21th)



  1. Most of the things falling in price are manufactured goods, due to technological improvements and productivity gains for decades.
  2. International trade is another reason. Many manufactured goods come from overseas, where labor costs are cheaper. So does global competition.


  1. things like education and medical care can’t be produced in a factory, insulted from global competition
  2. Private and public insurance companies pay most medical costs, so there tends to be little incentive for individuals to shop around for cheaper medical care. So does student loan


2. How about a higher inflation target

fredgraphThe U.S. Federal Reserve Board hasn’t hit its stated inflation target of 2% in more than four years

a higher inflation rate of, say, 4 percent would

  • allow inflation-adjusted interest rates to go even further below zero to help boost economic growth during a possible future downturn.


  1. price dispersion happens
    “when companies want to change their prices but for some reason can’t, inflation distorts prices from what they should be, which decreases economic efficiency.
  2. price hikes happen more frequently when inflation is higher, which gives more credence to “menu-cost” models of price setting

 (but studies find during the late 1970s and early 1980s, an era of high inflation, the absolute price changes don’t vary that much regardless of the inflation rate.)


3. We shouldn’t care inflation!

  1. Inflation time was also a time of slow growth, deep recessions and terrible asset returns.
  2. Harms like shoe-leather costs and menu costs don’t matter that much in a digital age.
    (economists shows inflation has almost no perceptible impact on productivity — and hence, on human well-being.)
  3. The costs of 10 percentage points inflation is only about as harmful as a 1 percent reduction in gross domestic product, investigated by professor Robert Lucas
  4. Real problems is that when prices rise fast, they also tend to bemore volatile — high inflation equals uncertain inflation [1]
  5. Although the historical correlation between inflation and inflation uncertainty is well-documented, that doesn’t mean the one causes the other.

a higher inflation target can get more people back into the ranks of the employed and shouldn’t be worried as long as it’s stable [2]


4. Government spending on Infrastructure

スクリーンショット 2016-08-19 1.18.02There is considerable unused labor remaining in the economy, especially prime-aged men who would benefit the most from an infrastructure push.

Government spending to roads and bridges benefits

  • If private-company interest rates rise, it means that capital is becoming more scarce for businesses because the government is crowding them out. If that looks like it’s starting to happen, we can always hit the brakes.




If inflation is predictable, lenders and borrowers can build it into their financing deals; nominal interest rates simply rise to take into account the shrinking value of money.Workers can ask for cost-of-living increases in their paychecks, effectively indexing wages to inflation. And businesses can build inflation into their investment plans.


The Fed’s so-called dual mandate, as laid out by Congress, is “to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

Fidelity‘s fund ideas

Three articles from “Fidelity – Markets and Insights – Fund ideas” that shows some recent views of fund managers.


Travelling FAST

“Excessive quantitative easing has meant that asset prices have been inflated and have not reflected underlying fundamentals”, and “I’ve been concerned that such artificial conditions cannot last forever, this has started to play out over the last 12 months.”

“As far as China is concerned, fears about an economic slowdown and currency devaluation are reflected in valuations.”

“While the portfolio has no exposure to the A-share market, I do own Hong Kong and US-listed consumer, technology, industrials (and services) names that I believe are good quality long term franchises.”


Value – about to make a comeback?

“Quantitative easing by central banks has distorted stock markets, with the result that growth stocks have outperformed strongly while value areas of the market have fallen far behind.”

“An underweight allocation to value stocks, examples of which are commodity-sensitive stocks, financials and industrials, while quality and growth areas of the market such as healthcare and consumer staples have become a very crowded trade.”

“The divergent performance of these style groups has now reached extreme levels and may be due for a reversal. Signs that inflation is re-emerging in Europe could be the catalyst for value to favour.”

“3 signs that inflation might be poised for a pick-up: 1. oil price; 2. wage inflation in Europe’s labour market ; 3. average level  of capacity utilisation due to underinvestment.”


All around the world

“Japan is a deep market with a good cross-section of opportunities”, and “Companies tend to be well-managed and conservatively run and, at the margin, there are signs that they are becoming more shareholder-friendly.”

“More than 15 years on from the boom these stocks have matured into very high return, cash generative businesses which dominate their local markets”, and “They’ve also started to demonstrate a willingness and ability to pay and grow dividends.”