Why the Fed Hates Inflation: 1.2 Trillion Dollars of Why
Upate: Those who have qualms about the methodology and underlying assumptions here would do well to consider Thomas Piketty’s thinking on page 210 of Capital in the 21st Century. He distinguishes between “real” and “nominal” assets, pointing out that real asset values climb along with inflation and growth, while nominal asset values don’t.
A simple rule of economic arithmetic that economists seem to studiously ignore:
Inflation transfers real buying power from creditors to debtors, with nary an account transfer visible anywhere on anyone’s account books. Inflation means that debtors pay off their loans over time with less-valuable dollars — dollars that can’t buy as much bread, butter, and guns.*
Higher inflation causes, is, a massive transfer from creditors to debtors.**
And the Fed is run by creditors. Inflation is, always and everywhere, very very bad for them.
How bad? Look at the fixed-income assets and liabilities of financial corporations:
Financial businesses are net creditors to the tune of $9-$14 trillion dollars.
If inflation was 1% higher than it is, it would transfer between $90 and $140 billion dollars to their debtors. Every year. For every extra point of inflation.
Add it up: an extra point of inflation over the last ten years would have cost financial businesses $1.2 trillion dollars.
It’s enough to get a banker’s attention.
And that’s before you even consider the Fed powers-that-be in their roles as equity shareholders, and the Fed’s dual mandate. By emphasizing low inflation over low unemployment — and stomping on growth whenever the bogieman wage inflation threatens to rear its head*** — the Fed maintains a pool of unemployed and weakly compensated employees that cripples labor’s bargain power and empowers the steady growth of corporate profits over labor earnings.
It kinda makes you think about Mankiw’s fourth principle of economics: “People respond to incentives.”
I’ve said it before: if it weren’t for inflation, the rich really would own everything, instead of almost everything.
* Some will caveat: this is only true of unexpected inflation, because contracts are written with expected inflation in mind. The proper response: since the future is impossibly uncertain, all changes in the inflation rate are unexpected.
** Meanwhile economists fetishize notions about menu costs and the like, which in their largest estimations are an order of magnitude smaller than the inexorable arithmetic effect described here.
*** It’s happening now.
Cross-posted at Angry Bear.