January 23, 2015

INFLATION IS A FUNCTION OF WAGE GROWTH:

Why is deflation continuing in Europe and Japan? (Tyler Cowen, January 22, 2015, Marginal Revolution)

1. Most countries have labor market incumbents with sweet real wage deals, deals which could not be renegotiated anew today because the world has seen a repricing of labor downwards for the wealthy countries.

2. Higher rates of price inflation would cut into those deals and thus high rates of price inflation are unpopular.  Voters don't quite understand the monetary economics here, but they have a vague sense that "inflation screws them."

3. We are no longer at the point where two percent inflation is easy to achieve in Europe or Japan.  Central banks are doubted.  To achieve two, they would have to shoot for four, and thus announce a target of four.  Few voters wish to hear this, and furthermore a credible stab at four percent inflation might in fact bring three percent inflation or maybe more.  A non-credible central bank can indeed still debase its currency, yet the achievable targets are given by lumpy notches, not a smooth sliding scale.  In the case of the eurozone, too high an inflation target is probably illegal as well, given the sole mandate of price stability.

4. We thus end up stuck having central banks which announce a target of two percent but undershoot it.

Posted by at January 23, 2015 3:53 PM
  

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