This past week Matt Yglesias over at Slate published a piece on “what the left gets wrong about the economy”. Basically, Yglesias says a society wide doubling of wages will invariably double prices, erasing the nominal gain and any increase in the standard of living. Raising real wages requires making things cheaper, and that happens when Schumpeter’s (originally Marx’s, but whatever) magical “creative destruction” is allowed to take place. The Internet may have destroyed print journalism, but the benefits of having the Internet – more online content, quick access to information, 4chan, etc. – outweigh the costs. By extension, we will all be made better when a similar “wave of technological change that’s transformed the media” starts “transforming the health care, education sectors, and transportation sectors.”
This mode of thinking gained a lot of traction after Daron Acemoglu and James Robinson published their widely popular book “Why Nations Fail”. In a nutshell, nations fail because entrenched elites find it in their interest to prevent the diffusion of new technology on the grounds that it challenges their power. Economists in the more classical tradition call this phenomenon dynamic inefficiency.
I’m inclined to agree with the idea that an economy operates best for all when it encourages innovation and technological diffusion. However, as I have pointed out before, how the rewards of new technologies are distributed deserves a ton of attention, lest we become a society where owners of technology (capitalists) reap all the gains while the masses stagnate.
I’m personally more interested in Yglesias first scenario, where everyone’s income doubles. Yglesia argues that while Slate doubling his salary would be met with an ear-to-ear grin, if everyone’s income doubles, then nobody’s real income changes. Gross Domestic Product (GDP, aggregate income) increases by 100%, but so does inflation, erasing any gains. The implications of this point are monumental for a society trained to fear inflation. Here, we have 100% inflation, with no serious damage done to the economy. The same number of goods are produced for the same number of people with the same purchasing power. The only difference being each good now costs twice as much in nominal terms. That’s okay though, because you now have twice as much income.
Inflation – like a lot of other economic issues – is at its core a distributional issue. For example, creditors hate inflation because their contractual agreements with debtors usually aren’t indexed to inflation. Inflation thereby transfers wealth from creditors to debtors. More generally, dollars are a unit of measure for the goods our society produces. Changing the number of dollars that represent those goods either increases or decreases the purchasing power one dollar has, but it doesn’t necessarily change how much we can produce/buy. Conversely, if the Fed targets a 5% inflation rate – which would be awesome – and distributes the newly printed dollars to the wealthiest 2% of earners – which would NOT be awesome – then that 2% of wealthy households will find themselves benefiting in terms of purchasing power even after prices rise 5%. Of course, they benefit at the expense of the 98% of the society who now experience a 5% decline in real income.
This may come as a surprise, but we don’t have to give the newly printed dollars to just wealthy people. We could as easily only give them to people at the bottom of the income range. For those people, inflation would increase their respective real incomes and standard of living. People with large incomes would lose, finding their unchanged number of dollars buying fewer goods. How tragic.
Point is – which I hope I’ve made clear – inflation matters only so much as how the new monetary units are distributed.