So … I asked a question to economists on social media the other day, as to whether there is some well-founded and orthodox explanation for why it is that voters, apparently, hate inflation so much. Because in my view, it is the central puzzle of the vibescession – if real wages are rising (and they are, particularly for the lowest income segments), isn’t it strictly irrational to have money illusion?
I got a lot of answers, most of them[1], in my view basically inconsistent with a Good Old Chicago Price Theory model of a representative agent with perfect information and consistent preferences. Which was what I was looking for – I wanted to be sure I hadn’t missed anything. As always, the problem isn’t that macroeconomics doesn’t have fully rigorous microfoundations – it’s that without “ad hoc” assertions like “people attribute wage increases to their own efforts but blame price rises on the government”, fully rigorous microeconomics doesn’t have macroimplications.
But … I’m still an economist, despite everything. So some ad hoc stipulations about inflation seem considerably less appealing than others. Although I can respect points of view like “people attribute wage increases to their own efforts but blame price rises on the government” or “the media screwed up by not explaining to people how the economy was doing”, in my gut I don’t like them. Because they’re based on assumptions that people will not just be wrong, but stay wrong, systematically for a period of years. And not just wrong about the aggregates – in most of these kinds of explanations, people have to be wrong about their own situation, their own preferences, or in general about things that you’d really expect them to be able to know.
Which suggests to me that another class of explanations might be more promising as a way to understand what’s going on. (And as I also rather cheekily suggested, this is an important question, because the basis of the political economy argument for monetary policy independence is that governments have an incentive to create inflation[2], so if they don’t, this might need to be revisited)!
The two papers I’ve linked above share a theme with something I posted about earlier this year, not realising at the time that it was relevant to the vibecession. In “Hayek’s Hamburger Hell”, I noted that one reason that most businesses don’t adopt dynamic pricing is that customers absolutely hate it, and are very resistant to economists ‘splaining why they shouldn’t.
And what’s inflation, but a kind of dynamic pricing? When the price index rises, it’s summarising a lot of different commodity price movements, some of which can be large in relative terms. This is particularly true of food and fuel, which are excluded from the “core” measure not because they’re unimportant (they’re not!) but because they’re particularly volatile. In undergraduate economics you’re taught that this is almost a good thing – the price level shift has an “income effect” (the same nominal income buys a smaller basket of goods), partly offset by a “substitution effect” (you can claw back some of that loss by rebalancing your own consumption bundle to consume more of the goods whose relative price has fallen). So an identical percentage move in CPI and nominal wages ought to leave you better off – as I say, it’s an easy undergraduate exercise to prove it with curves and lines on a graph.
But of course, the “substitution effect” kind of sucks. It’s a cognitive load, placed on people who, in my view, really aren’t in any shape to be bearing more cognitive load. You have to find out what things have changed in relative price, potentially go through an extended trial-and-error period of changing your weekly shop, and so on[3]. If the only way to get your nominal wage increase is to either change jobs or have an awkward conversation with your boss about the cost of living, then that also really sucks.
So maybe the problem isn’t that the pervasive money illusion we’re seeing doesn’t have microfoundations, but rather that the microfoundations themselves need microfoundations. “Preferences” aren’t just atomic properties of an individual, they are the outcome of the activity of choosing. And choosing is not only a costly activity, but one which requires resources in limited supply.
[1] It was also suggested to me that the problem is in the numbers themselves – that the tapering of pandemic-era benefits means that the real wages data didn’t actually describe real personal disposable income very well for a lot of households. Someone suggested that “if you were only looking at your own pocketbook, the way you would have experienced that period would be that Trump introduced a Scandinavian welfare system and Biden cancelled it”. I’m not realistically in a position to assess this on the numbers but thought it worth mentioning.
[2] Karl Whelan put me right on this to some extent, saying that the best formulation of the argument was that the government incentive was to run a deficit budget in the year before an election, on the basis that the output boost would be noticed immediately while the inflation took longer to arrive. But even so – I think it very much affects the case if people really hate inflation these days.
[3] Straying a bit into “structurally incorrect beliefs”, I think it’s also possibly significant when the price index is made up of daily purchases combined with more infrequent consumer durables. It’s a known phenomenon that people systematically under-report alcohol consumption, because if you ask someone “how much do you drink in a week on average?”, they will give the answer for a typical week, rather than including Christmas, birthdays and special occasions then dividing by 52.
Good post. Sticker shock when buying food or fuel seems to really bother people. The frequency of those purchases definitely shape peoples' perception of prices. Not having seen this kind of inflation for decades was also a way for things to be annoying in an unfamiliar way. The cognitive load you mention could be partially due to dealing with this novelty.
Employ the flip side of the logic presented in textbooks w/r/t the politics of trade and it's easier to understand. (Refresher for the curious: the benefits of trade are diffuse, but the costs are concentrated, so collective action dynamics will push towards protectionism without a broad consensus across the political class that this is not in the long-run interests of the nation (such consensus obv no longer exists, which is the first warning sign that trad political economy logics need updating.))
In the political economy of crisis-fighting the benefits of preventing 15% unemployment are concentrated: a supermajority of people have jobs either way. But the costs are diffuse: everyone experiences inflation. You think Elon and the network of used car dealers that love him give a shit about someone else's job? No, that's why the WSJ editorial page goes pre-emptively crazy about inflation whenever a Democrat even thinks about helping anybody. So the business class is against inflation always, and marginal voters whose jobs have been saved then employ some of the logic you described: "my job/wages are earned, but inflation takes from me, my bosses hate it and that's how my bread gets buttered, so I'll vote against it too".
Since the coordination mechanism for anti-inflation coalition-building is simple and inexpensive -- voting, on a pre-specified day known to all, as opposed to extended/indefinite lobbying for protection, as in trade policy -- it does not face a collective action problem. Thus, there is a very strong anti-inflationary bias in most democracies whose salience is a function of how far away the election is.
In the current situation "interest rate inflation" is pricing people out of housing in the places where job/wage growth is high, so there are both diffuse *and* concentrated costs associated with the current inflation. Real wage growth might keep up with CPI but not necessarily with a doubling of rents/mortgage costs. Irrespective of whether you prefer CPI/PPI, household balance sheets are pinched on both ends, but only one of these shows up in inflation statistics. Now look at recent voting patterns: Harris didn't get votes in the suburbs and cities that she was counting on, that's where rents and mortgages are still very elevated relative to incomes.
I.e., it's not just the inflation that's unpopular. It's the monetary policies being used to combat inflation that are also unpopular, which leaves governments with no good options other than to stick to principle and go down with the ship. In related news, every incumbent outside of Switzerland is getting smoked, irrespective of ideology (with the exception that zero progressive/left parties are winning), and Switzerland kept inflation low.
Chwieroth and Walter's research on the increasingly "Great Expectations" voting publics have for government macro management makes this a very difficult balancing act. In normal times with high levels of elite consensus that might be manageable without too much disruption, but in our current times of system-wreckers we're headed for system-wrecking.
Either way, hopefully MMTers and other left factions start taking this stuff more seriously or else we'll blast ourselves back into premodernity. Normie voters don't want a return to 1950s class politics, clearly. Kamala Harris got more votes in Vermont than Bernie Sanders did last week. Workers own assets now (2/3 of American households own stocks now, in the 1980s it was 20%). They want normie stabilization politics, not DSA-style "revolution" but 1990s technocracy, at least in the US. In fact they never stopped wanting it, US voters have voted for the candidate they perceived to be the "most moderate" in every recent election.