In recent days, there’s been a twitter debate about whether changes in employment drive the inflation process:
I thought of this debate when reading about the sudden rise in the Argentine price level. Here’s Bloomberg:
At shops all across Argentina, from cafes to kitchenware vendors, scores of small-business owners woke up Monday to find some version of the same notice in their inboxes: Their suppliers had hiked prices 20% overnight. . . . Sharp price hikes appeared early for electronics and home appliances Monday. MacStation, an official reseller of imported Apple products in Argentina, raised its computer prices nearly 25% while local e-commerce site Precialo, which tracks pricing history, showed refrigerator, washing machine and TV price tags north of 20% in the past week.
In fairness to Blanchard, prices are more flexible in a high inflation country such as Argentina. But these sorts of countries represent a sort of lab experiment: What happens when you rapidly boost the currency stock in a country not at the zero bound? Or (in this case): What happens when a political shock occurs that leads to faster expected future growth in the money stock? The result is an almost immediate increase in the price level. Yglesias is correct. It’s not “mind control”; it works through the public having a rational forecast of the future path of policy. Argentine citizens have been here before.
I don’t have data on the Argentine labor market, but I doubt that the unemployment rate fell sharply last night. The Phillips curve doesn’t tell us anything useful about the inflation process in Argentina.
In fact, it is monetary policy that drives inflation–not the labor market. In an economy where prices are not sticky, it does so without much change in unemployment. In an economy with sticky prices, unemployment often changes as inflation changes. But that’s an effect, not a cause.
In America, inflation is much lower and prices are stickier. But even here, changes in monetary policy affect nominal GDP growth in a very short period of time, within weeks. The so-called long and variable lags are a myth. Economists have used lags as an excuse for the fact that they use the wrong model. Keynesians use interest rates to indicate the stance of monetary policy, while monetarists rely on the monetary aggregates. Both of these indicators are flawed. When their predictions don’t pan out, they use long and variable lags as an excuse.
If I were trying to make a living as a fortune-teller, I’d say, “After a long and variable period of time, I see you having some health problems.” In the 1960s, it took 10 years for rising interest rates to produce a recession. The interest rate increase of 1994 didn’t lead to recession until 2001.
The best indicator of monetary policy is market forecasts of future NGDP. And monetary policy affects market expectations of future NGDP with no lag at all. When next year’s expected NGDP declines, current NGDP tends to fall after a relatively short period of time. There are no long and variable lags in monetary policy.
Update: Kevin Erdmann points out that our price level might soon be a bit less sticky.
