I’m quite tongue-in-cheek in asking that question, but nevertheless: I present for your delectation what at first blush seems like a revealing bit of chart porn (hat tip: Zero Hedge):
You could flip this upside down and replace “Earning Yield” with “PE ratio.”
The data displays a remarkably regular relationship. Equity investors seem to be most optimistic about future economic (or at least earnings) growth when the inflation rate is 4.3%. (It would be interesting to see: did this relationship hold, albeit with the inevitable noise from smaller samples, in shorter sub-periods — and if so, which sub-periods? In particular curious: did it hold equally pre- and post-1971?)
Can we draw any conclusion from this? i.e.:
• Market conditions that are most conducive to economic growth are revealed by a 4.3% inflation rate.
• Equity investors display the most “irrational exuberance” when the inflation rate is 4.3%.
I’d love to hear whether Market Monetarists and MMTers think this has any useful import.
Cross-posted at Angry Bear.
Comments
5 responses to “Should The Inflation Target be 4.3%?”
[…] Cross-posted at Asymptosis. […]
This is interesting to me, because I had been thinking that for various reasons a 4% inflation target would be optimal for a number of reasons.
1) Housing prices and mobility. Historically, housing prices rise with the cost of inflation, and the transactional cost of selling a house is about 10% of its value. In order not to take a nominal loss, the value of the house needs to rise 10%. At 4% inflation, this happens in 2.5 years: at 2% inflation every 10 years. Thus, when inflation is too low the workforce becomes less mobile.
2) Inflation pressures on wages. When inflation is too low, there is not enough pressure on workers to make them willing to strike for higher wages. Slightly higher inflation would help here. The times when inflation was around 4% (late 80s and 90s) felt like there was a better balance of division of productivity gains between capitol and labour.
3) Sticky wages. Wages are sticky in nominal dollars, but it is fairly easy to have them go down in real dollars by not adjusting for inflation. A higher inflation rate makes it easier to adjust wages downwards.
I think I’ve seen most of these floating around the blogosphere somewhere. Nice to see another reason for supporting a higher inflation target.
@ralmond
“3) Sticky wages. Wages are sticky in nominal dollars, but it is fairly easy to have them go down in real dollars by not adjusting for inflation. A higher inflation rate makes it easier to adjust wages downwards.”
What if negative real earnings growth is what led to a recession?
Milton Friedman might say that people would start to expect 4.3%, and then you would need a higher number.
“In particular curious: did it hold equally pre- and post-1971?”
Excellent question.
In theory, the long run level of inflation doesn’t really matter. What matters is that it is close to what people expect inflation to be. It’s not surprising that there’s a big clump in the middle where things are running smoothly and if you depart from that clump, things get bad. I don’t think there’s anything particularly special about 4.3% per se, what matters is consistency and regularity.