Tyler Cowen has a new Bloomberg column that starts off as follows:
With inflation now rising faster than at any time in the last four decades, economists are debating which group suffers more from inflation, the poor or the rich. This kind of economy-wide question is not easy to answer, especially when rates of inflation have been so low in recent times and hard data are scarce. Nor is it obvious how exactly to compare the losses to the poor to the losses to wealthier groups. Nonetheless, the arguments suggest that the poor are likely to take a beating.
Tyler’s right that this is not an easy question to answer, as the term ‘inflation‘ applies to many different and somewhat unrelated phenomena. Thus an adverse supply shock that raises the price of specific commodities while reducing real GDP is often called “inflation”. Inflation is also the outcome of a positive demand shock that raises a broad range of prices while also increasing real GDP. Not surprisingly, the welfare effects of a shock that decreases real GDP will not be the same as the welfare effects of a shock that increases GDP.
And that’s just the beginning. One must also distinguish between short and long run effects. I believe that a highly expansionary monetary policy raises welfare in the short run, helping both the poor and the rich (albeit for different reasons–less unemployment for the poor and higher real asset prices for the rich.) And yet I oppose such policies because I believe the long run effects are quite negative, and more than offset the positive short run impact. More specifically, highly expansionary monetary policies can create an unstable economy, a cycle of boom and bust. They also lead to higher real tax rates on investment income, slowing economic growth.
Here’s Tyler:
The poor is the socioeconomic group that finds it hardest to purchase a home, and real estate seems to be one of the best inflation hedges. U.S. real estate prices have been on a tear for some time, including through the recent inflationary period.
Rents are rising at a rapid clip, due to the mix of rising demand and bottlenecked supply. The biggest losers there will be the poor.
This is all true, but a word of caution. While real estate is an inflation hedge, I doubt the recent increase in real estate prices has much to do with that fact. Rather the price of homes has become increasingly expensive during the 21st century due to a combination of NIMBYism and low real interest rates. The low real interest rates do not necessarily affect monthly rents, but NIMBYism and tighter regulation on mortgage lending to the working class do push up rents.
Certainly real estate is a significant part of “inflation” in an accounting sense. But in my view it makes more sense to analyze specific products such as housing in a microeconomic context. How are the poor affected if the real or relative price of housing rises?
In other words, one reason why Tyler’s question is hard to answer is that it is actually multiple questions:
1. What is the impact of an expansionary monetary policy on the poor and rich? Is the effect different in the short and long run? Does the effect depend on whether the policy was anticipated or unanticipated? Does it depend on whether the tax system is indexed to inflation?
2. What is the effect on the poor of NIMBY regulations that make it more difficult to built homes?
3. What is the effect on the poor of regulations that restrict health care production, making health care more expensive?
4. What is the effect on the poor of a decision by OPEC to reduce oil production?
And I could name 100 more such questions. These all get lumped together as “inflation”, and in an accounting sense they are a part of the inflation process. But they are radically different questions.
Here are two somewhat more clearly defined questions:
1. Would the poor in America benefit (on average) if the Fed announced today that its monetary policy going forward would be slightly more contractionary than currently expected by the markets?
2. Would the poor in America benefit (on average) if the Fed announced today that its monetary policy going forward would be much more contractionary than currently expected by the markets?
I believe the answer to the first question is yes and the answer to the second question is no. I’d give the same two answers if you asked me about the middle class. And I’d give the same answers if you asked me about the rich.
PS. Here’s an analogy. If patient asked a doctor what was the impact of a fever of 101.4 degrees, the doctor might respond by first ascertaining the cause of the fever. Inflation is sort of like a fever, evidence of certain underlying conditions affecting the economy. But the focus should be on the underlying conditions, not the symptom.
PPS. Shorter version of post: Never reason from a price level change.
READER COMMENTS
Alan G
Dec 15 2021 at 2:56pm
Scott is channeling his inner Hyman Minsky!!!! 🙂
Yes, interest rates are low. We just closed on a condo last week with a nice low interest rate. We financed half of it to get at least five years of a tax break from the mortgage interest deduction. In our area there is not so much NIMBYism but building higher end dwelling units whether they be appartments, town houses, or detached houses. We are starting to see duplex building on existing property provided the land can support two dwelling units. The home we are selling sits on almost 12,000 sq ft and could support a duplex.
Alan Goldhammer
Dec 15 2021 at 2:57pm
It looks like the formatting did not take and Scott’s quotes are jumbled with my response. Can’t fix it once it gets posted.
nobody.really
Dec 15 2021 at 3:52pm
Welllllll … crap. That’s depressingly insightful. I barely manage a tenuous grasp of macro as it is–and apparently even that claim is exaggerated.
I’ll process this mañana.
Andrew_FL
Dec 15 2021 at 3:52pm
This comes as quite a shock, considering you’ve spent over a decade calling for highly expansionary monetary policies.
Scott Sumner
Dec 15 2021 at 5:30pm
No, I’ve advocated steady NGDP growth, at roughly 4%/year–level targeting. I’m neither a hawk or a dove. I’m an owl.
rsm
Dec 15 2021 at 5:38pm
Why do you trust government statisticians who impute half of the GDP statistic inputs, and throw away the standard errors on the survey inputs?
Does your blind faith in magical numbers such as GDP signal the religious character of your economics profession?
Why does anyone still listen to economists, when our everyday lived experience directly contradicts their theories?
Scott Sumner
Dec 15 2021 at 8:37pm
Why do you keep asking the same questions over and over again, while ignoring my responses?
rsm
Dec 16 2021 at 12:37am
Did I miss a response of yours?
If you keep making the same mistake in your main articles, without acknowledging my objections, why shouldn’t I continue to call you out?
Am I expecting a ban in 1…2…3…?
Scott Sumner
Dec 16 2021 at 12:20pm
“Did I miss a response of yours?”
You certainly act like you did.
Henri Hein
Dec 16 2021 at 2:36pm
I can’t speak for Scott, but one problem I have is it’s hard to understand what your objections are. For instance, take this statement:
GDP is clearly not a magical number. There is a small army of trained professionals at BEA that calculates this number every quarter, based on an overwhelming amount of statistical input. That doesn’t mean the concept of GDP is flawless and nobody thinks of it that way. If you want to point out some of the particular problems with the GDP measure, that’s fine, and I’m sure Scott or other economists here would be willing to engage with you on specific points. Calling it a “magical number” does not tell us what your objection is and does not signal an intent to dialogue.
That’s not even taking into account that this post is about inflation, not GDP.
Peter McCluskey
Dec 15 2021 at 6:24pm
The obsession with rich versus poor distracts people from inflation’s important shift in wealth: from the risk-averse to the risk-tolerant.
Thomas Lee Hutcheson
Dec 16 2021 at 6:26am
Doesn’t the question depend as well on whether the market was correctly expecting the Fed’s long term actions? My interpretation of the market rally (and slight fall in the TIPS) on Powell’s press conference was that it confirmed expectation that Fed policy was still to target average inflation at pretty close to 2.3% CPI. It reduced the tail risk that the Fed was going to allow inflation significantly above its stated target over the long run.
As for the negative effect of “demand” inflation on raising the deadweight loss of some unindexed taxes (a valid concern, capital gains should just be indexed, period) one ought to take account as well that the higher collections would reduce the structural deficit and do reduce that drag on real investment.
Yaakov Schatz
Dec 16 2021 at 11:13am
I would assume the question is: Assuming the rate of inflation does not affect growth, who gets hit hardest from the inflation?
I lived through hyper-inflation in Israel which reached 30% a month. It requires so many extra wasteful activities. It makes price comparison very difficult. It requires investing any excess cash immediately when you get it. It requires continually adjusting the prices of what you sell and continually pushing for a raise. Now inflation of 1% a month is not that bad, but it also would be a pain and people who do not have the patience for all these activities will be hit hard.
Even if inflation always affects growth, one could answer the question in two parts: as to the cost of the inflation itself and to the cost/benefits of its effects.
Philo
Dec 16 2021 at 12:07pm
As you note, there are many different scenarios that would constitute “greater inflation,” in which the effects on different classes of people would be different. And even if we spelled out a particular scenario in detail and inquired whether it would have a greater effect on the average rich person or on the average poor person, there would be an issue about the units in which these effects are to be measured. Suppose that in one such scenario everybody’s wealth and prospective income were changed by x% in real terms–uniformly, across society. (It matters not whether ‘x’ is positive or negative.) Measured in dollars, this would have a greater impact on the rich than on the poor, while, due to the declining marginal utility of wealth, it would have a greater utility/welfare effect on the poor. Likewise, if everyone’s real wealth and prospective income were increased by x%. In comparing the effects rich and poor, the unit of measurement is crucial.
Jose Pablo
Dec 16 2021 at 6:45pm
“economists are debating which group suffers more from inflation, the poor or the rich”
Why is that question relevant? … after all being rich or poor is not something you can “use” as a hedge against inflation, so what’s this analysis relevant for?
It is as useless as debating, which group suffers more from inflation, men or women, whites or people of color, teachers or students, uber drivers or uber users, drug addicts or people with no addictions, ….
Which “individuals” suffer more from inflation and why?, is a much more relevant question. From the right answer to that question, you can, very likely, take steps to avoid being in the “f … up by inflation” group.
For example:
Individuals invested in long term government bonds (never a good idea to lend money to the very same people that can “drive inflation up”)
Individuals invested in long term bonds.
Individuals with money on their savings accounts
Individuals with no job
Individuals working in companies / sectors with very limited pricing power.
….
Brian
Dec 25 2021 at 10:31am
Aren’t you omitting the affect the inflation has on currency values that only affects the rich or investment class? Who wants their return on investments decrease in inflation-adjusted returns since the poor and middle class are paying the debt with currency whose value is reduced by inflation? What that means to the rich holders of notes is a reduction in return.
That would explain why members of congress, who are bought and paid for by the same wealthy donors who are hurt by inflation, are pushing this fairy tale that increased social spending somehow hurts the poor because of increases in prices (as if they care about the poor). Much of that inflation could go away if businesses were not jacking up prices to make up for losses in 2020.
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