The Psychology of Inflation

I’m late to this party, but I was intrigued but this Matt Yglesias post about why people seem to hate inflation so much:

Now a fancy-pants economics blogger can tell you that the most important price in the economy is the price of labor and the price of labor is equal to workers’ incomes, so a general increase in the nominal price level is necessarily a general increase in nominal incomes. But nobody seems to believe that. Instead people are convinced that gasoline and milk are the main prices in the economy, and that a general increase in the nominal price level is necessarily a general decline in real incomes.

Meanwhile, Noah Smith disagrees, citing evidence that inflation tends to actually erode people’s real income, at least in the short term. That’s a good piece of evidence, but I’m not convinced.

Not to be one of those pith-helmeted Brooksian pundits, exploring the American hinterland Joseph Conrad-style, but my sense of the average person’s understanding of inflation is a lot closer to Yglesias. Average wage workers tend to have a general sense of the things they buy the most, and when those prices increase they don’t like it; I don’t think people are paying enough attention to actually calculate change in real income as per Smith’s graph. As near as I can remember this is how I used to think before I learned any economics. (For an international example, I’d say the German/ECB hard-money fixation is clearly irrational and looks set to destroy the Eurozone.)

There’s actually a good passage from the famous paper about the economics of a POW camp on this point:

There was a strong feeling that everything had its “just price” in cigarettes. While the assessment of the just price, which incidentally varied between camps, was impossible of explanation, this price was nevertheless pretty closely known. It can best be defined as the price usually fetched by an article in good times when cigarettes were plentiful. The “just price” changed slowly; it was unaffected by short-term variations in supply, and while opinion might be resigned to departures from the “just price”, a strong feeling of resentment persisted. A more satisfactory definition of the “just price” is impossible. Everyone knew what it was, though no one could explain why it should be so.

The background for this is that a bit of inflation is a form of monetary stimulus, price adjustment, and debt erosion that is desperately needed right now, especially in Europe. For ways that we might work around this, Steve Randy Waldman (always an excellent read, by the way) had a great proposal for inflation-protected “starter savings accounts.” They’d have to be heavily regulated and size-capped to avoid being abused by the rich, but they could ease that inflation anxiety among the middle class, who then wouldn’t be used as human shields by the creditor class.

Ryan Cooper

Ryan Cooper, a contributing editor of the Washington Monthly, is currently the Washington correspondent for The Week.