One of the difficulties with understanding banking is that one needs to use relatively complex macro models to see how the formal banking system interacts with the non-bank financial system. Analysis based on looking at the motivations of a single bank or based on models where only the formal banking system exists will be misleading. Stock-flow consistent (SFC) models are one of the few attempts at such a modelling framework.
The first thing to note is that there are multiple ways of estimating r*. I am not too concerned about which one is used, since the ones that I have seen share an important property, which I will shortly describe.
This paper is an example of why I have largely given up on the DSGE literature. From my perspective, the contents may be summarised as:
The authors describe r*, which is a necessary empirical complement to the dynamic stochastic general equilibrium (DSGE) literature. The DSGE literature assumes that the policy rate (and its expected path) are a key driver to macroeconomic dynamics. The value of r* is required to both assess the accuracy of the models, as well as to provide a guidepost to policy.
They then look at a variety of estimates of r*, and note that they have all moved dramatically as a consequence of the pandemic and the monetary policy response to it.
They discuss various theories as to why r* may have gone up, or possibly down.
They then note that the uncertainty about r* should be taken into account when looking at policy.
(In discrete time, the model state is defined on a time axis that can be labelled as integers: step 1, step 2, etc. In a continuous time, a model’s time axis is the real axis. A discrete time model can be thought of as being defined by difference equations, while continuous time is normally defined by differential equations.)
Even if one believes that asset price increases represent inflation, the general reaction among North American central bankers would be to think you are crazy if you think asset prices should be included within an inflation target mandate. (I am less sure about the reaction of Continental European central bankers.) Although they might accept that exuberance in financial markets should be toned down, targeting asset prices directly poses many problems.
I was recently on a podcast with Steven D. Grumbine to discuss inflation. Link: https://realprogressives.org/podcast_episode/episode-268-there-is-no-magic-pricing-fairy-with-brian-romanchuk
The podcast description from the webpage is.
“Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
Milton Friedman
This quote by the grandaddy of neoliberal economics is from 1963. Some in the mainstream have been dining out on it ever since.
According to our guest, author and blogger Brian Romanchuk, neoclassical economics relies on mathematical models and fail to capture the complexity of real-world inflation. He highlights the importance of understanding the supply and demand dynamics in setting prices and explains that inflation can be influenced by factors such as supply chain shocks and changes in the labor market.
Brian also points out that it’s not enough to blame inflation on corporate greed; after all, corporations are always driven to maximize profits. He mentions the Cantillon effect, which suggests that the first recipients of newly created money benefit from inflation as prices go up, while the poor and working class bear the brunt of higher prices down the road.
Brian and Steve discuss inflation constraints on fiscal policy. Brian argues that while extreme fiscal policies could lead to inflation, most of the time, fiscal policy is relatively moderate and does not have a significant impact on inflation. They criticize the government for not trying to set prices and argue that the government often follows the private sector’s lead, making things worse.
This is a discussion of some topics around inflation. Although some of the discussion related to the concerns of my book, a lot of it relates to some of the recent political economy controversies with inflation. It was fun, although I am not sure how well suited I am to the podcast format.
Otherwise, I have been plugging away at fixing weak points in my inflation manuscript. Rather than waste reader’s time by rushing out some random comment, you are encouraged to get your dose of Romanchuk (and Grumbine) content via the podcast.
