Recent inflation prints have sparked hand-wringing. I suppose I cannot put off any longer writing about prices, but I confess it is still not entirely clear to me what is the question we are meant to be answering.
Economics discourse is dominated by Anglo-American experience. The double-digit inflation in consumer prices of the 1970s prompted big shifts in economic theory. Although nothing like that has happened since the Volcker recession, it still strongly shapes discussions of inflation.
Let me try to add a couple of observations to this conversation, from a different angle.
Minsky on capital asset pricing
Josh Mason and Perry Mehrling prompted me to revisit Minsky's "two-price" model of investment, articulated in his 1975 book John Maynard Keynes. I didn't give this contribution a great deal of attention in the book. I stand by that choice, though not because I find the financial instability hypothesis more interesting. Rather, I would say that the two-price model and the financial instability hypothesis share the same basic insight.
Specifically, Minsky reminds us that capital assets are financed: productive capacity is bought with borrowed money. That borrowing commits producer to periodic payments—principal and interest on the loans or bonds. Most of these periodic payments are fixed in nominal terms: loans and bonds require the borrower to pay specific amounts of money on specific dates.
The name of this idea, which Minsky gave it in 1954, is the survival constraint: debts must be paid when due. But by the time he wrote down the two-price version, attached to the work of Keynes, he had stopped using that name, perhaps because it had not caught on with other economists. The survival constraint is the difference between debt finance, which imposes cash commitments, and equity finance, which does not. A bond or a loan requires the borrower to come up with cash to make payments; an equity share does not constrain the issuer in the same way. These schematic T accounts give an indication of the structure:
Minsky gets a theory of investment out of the relationship between the price of current output and the price of investment goods: when product can be sold at a high price, it makes sense for producers to invest in capital assets, taking on the payment commitments of new borrowing with confidence. When product cannot be sold, or can be sold only for a low price, then it makes sense for producers to try to get out of their burdensome debt, by paying it down or by declaring bankruptcy. If everyone tries to do this at the same time, spending and prices collapse.
Interpreting price changes
Minsky's logic might inform current discussions as well, though our circumstances are different from his. A couple of observations.
First, inventories. The most important position-making asset in goods supply chains (aside from cash) is inventory. If inventory cannot be sold, cash commitments bind much more severely. This graph shows the number of months of inventory at various points in the supply chain from the beginning of the COVID-19 pandemic through March 2021:
Across the supply chain, inventories spiked from typical levels around 1.4 to above 1.6 months' worth of inventory, as public health restrictions on movement came into effect. That excess was worked off during the spring and summer of 2020. Retail inventories in particular stabilized at a low level. Then starting in February 2021, inventories spiked downward as activity and spending picked up again in the US. Inventories of both retailers and wholesalers remain low relative to pre-pandemic levels. Restocking will lead to some combination of price increases and investment in capacity.
Second, nominal debts. Much of Minsky's model applies to any borrower, businesses but also households and government. Any borrower must make payments out of current cash inflows. Because debt payments are fixed in nominal terms, they become easier to service if the income flows out of which it is serviced are inflated. So whenever a rise in prices favors borrowers, it eases the burden of debt. In this regard it matters a great deal which prices are rising, and in particular whether they flow through to wages, the price of labor and the source of funds for household debt payments.
Third, central banks. Both the Fed and the ECB are unlikely to stop asset purchases hastily. But at the same time, both central banks have shown at least some shift toward "talking about talking about tapering." I am more inclined to watch what they do than what they say. But central banks are obliged by their mandates to respond to price movements, whether or not asset purchases actually affect the prices they are watching. So price movements will tell us something about future financial conditions.
Perhaps I've held off saying anything on inflation because all the action is in the details, and those details are messy and hard to observe. I am convinced, however, that a clear view on the connection between prices, finance and cash flows would improve the discussion.