A lot of non-economists believe the inflation fallacy. I’m an expert on what non-economists think about economics. That’s because I have spent the last 30 years trying to teach non-economists how to think about economics.
Sometime in February, I will ask my ECON1000 students: “So, why is inflation a bad thing?”
I can anticipate the look on their faces. Some will give me that look of sympathy, normally reserved for those who aren’t too bright. Others will look like they know this must be a trick question, since I wouldn’t ask anything that were really quite so obvious. Finally one will answer.
“Because if all prices rise 10% we will only be able to afford to buy 10% less stuff. Duh!” Except the “Duh!” is silent.
That’s the inflation fallacy.
Why is the inflation fallacy a fallacy?
Apples bought must equal apples sold. What is an expenditure to the buyer of apples is a source of income to the seller of apples. Every $1 rise in the price of an apple means the buyer is $1 poorer and the seller is $1 richer.
But there’s a problem with Rowe’s argument; in fact, it’s a problem that crops up again and again in economics: wilful obtuseness on matters of politics. Economists want so much to be an a-political ‘scientific’ discipline that they’d rather sit around being smart-arses and saying stuff like: “if all prices double, and all wages double, that would have no effect on the quantity of labour demanded,” than actually addressing what actually concerns people about inflation.
When people say they are “worried about inflation” what they actually mean is that they are “worried that their real wage will be eroded because commodity prices rise faster than their wages.” Inflation is a worry because it represents one (very effective) way of bosses reducing workers’ wages and increasing profits without the workers being in a position to do anything about it.
If unemployment is high and unions are weak – as is currently the case in the UK – then workers are not in a position to demand rises in their real wage, so commodity inflation represents a threat.
Now, as Smith argues, there are good reasons to think that the ‘best’ situation is one of moderate, positive inflation; but that necessary upward price adjustment cannot occur simultaneously across all sectors of the economy. Someone has to move first. So the question arises: who shall bear the short term burden of differential price rises, workers or firms?
There has been a great deal of opposition to fiscal stimulus because it is claimed that fiscal stimulus will lead to inflation. This is obviously wrong in the present situation of high-unemployment, because if there is excess capacity in the economy (and what is unemployment but excess capacity?) then using some of that extra capacity will not necessarily result in inflation.
But warnings of inflation are a very effective tool for cowing the masses into doing what the ruling class wants. The ruling class want weak trade unions, low inflation, and a high profit share out of total income. The masses ought to want a high wage share out of total income, strong trade unions, and moderate inflation. Insofar as a trade-off exists between unemployment and inflation the masses ought to prefer a situation of full employment and moderate inflation, over a situation of high unemployment and low inflation.
But there are many cognitive biases that exist to prevent the masses from expressing a rational preference. Although people fear unemployment, even in the worst economic situation, the majority of people remain employed. Unemployment is awful for the people experiencing it, but those people are only ever one small fraction of the total working population. But inflation is experienced by everyone in the working population.
The salience effect leads people to overweight the importance of things that are in front of them. People spend more time shopping and looking at rising commodity prices (especially of big-ticket items like petrol) than they do looking at unemployment figures. The just world fallacy and fundamental attribution error leads people to blame individual unemployed people for being unemployed, rather than blame the impersonal economic forces that are actually its cause. As George Orwell writes in The Road to Wigan Pier, this can even lead people to blame themselves:
When a quarter of a million miners are unemployed, it is part of the order of things that Alf Smith, a miner living in the back streets of Newcastle, should be out of work. Alf Smith is merely one of the quarter million, a statistical unit. But no human being finds it easy to regard himself as a statistical unit. So long as Bert Jones across the street is still at work, Alf Smith is bound to feel himself dishonoured and a failure.
On the other hand, if the supermarket jacks up the price of petrol, I – and many others – are far more likely to demand that Something Must Be Done; and we are more likely to be listened to, because petrol prices affect more people, and their impact is more immediate and obvious than that of unemployment.
In summary: anti-inflation policy is a wedge issue that enables the rich to persuade the poor to vote against their own interests. I have no idea what to do about this.