Matt Yglesias has a post entitled:
Trump would make inflation worse
I have a slightly different view. I’d make the following two claims:
1. Trump would not make inflation worse.
2. Trump would make “inflation” worse.
That obviously calls for an explanation.
Economists define inflation as the percentage change in the price level. Alternatively, it can be viewed as the percentage decrease in the purchasing power of a dollar. When the dollar loses purchasing power, the price of goods, services, and labor goes up. By itself, this has no real implications. It’s kind of like a two for one stock split—just an accounting change. (And no, inflation is not the change in the money supply.)
In our textbooks, we justify the widespread concern about inflation by pointing to various subtle “costs of inflation”:
1. People visit ATMs more frequently, to avoid holding lots of currency that is losing purchasing power.
2. Restaurants have to redo menus more frequently.
3. People are less likely to save because our tax system taxes the nominal return on capital.
But this is not why the average person cares about inflation. If you ask people, they won’t say:
“More trips to the ATM” or “costs of changing menus” or “deadweight cost of taxation of nominal capital income.”
They’ll say, “Duh, obviously inflation’s bad because you have to pay more for stuff, and that lowers your standard of living.”
But that’s wrong. Inflation doesn’t directly hurt consumers, as a pure inflation causes incomes to rise as fast as prices. Wages are also a “price”.
It’s true that there are cases where incomes don’t rise as fast as prices, and in those cases people are hurt. But then the thing that is hurting them is not inflation; it’s the thing that causes incomes to rise by less than inflation. It might be the thing that reduces real GDP—some sort of real problem like a crop failure or an oil embargo. Some people can also be hurt by redistribution of income from one group to another. But in all of those cases it’s not really the inflation that hurting people, it’s the falling real GDP or the redistribution of income from one subgroup to another.
The Fed is targeting inflation at 2%. Right now it’s above 2%, but the markets seem to expect it to fall to close to 2% in a few years. I don’t believe Trump being elected would change that fact. Hence:
1. Trump would not make inflation worse.
However, Trump might well worsen the things that people actually care about when they say they care about inflation. Yglesias mentions examples such as Trump’s promise to sharply raise tariffs on imports. I believe that this would make most American feel worse off. But not because the CPI would begin rising at faster than 2%, rather because the Fed would be forced to depress non-import prices in order to maintain its 2% inflation target. In that sense, Trump’s policies might cause “inflation” in the way that the public wrongly conceives of the term. That is:
2. Trump would make “inflation” worse.
You might say I agree with the bulk of Yglesias’s post, while not being on board with the post title. Yglesias also mentions immigration and residential zoning as areas where Trump’s views differ from those of traditional Republican supply-siders. And although Trump has promised to pay off the entire national debt in his second term, his actual tax and spending proposals suggest a big increase in the budget deficit. This could further raise real interest rates, hurting investment. In fairness, Trump would probably also do some tax and regulatory changes that would boost GDP growth, so the net effect of his policies is uncertain. Yglesias’s post assumes a second Trump term would be more “populist” than his first term, as he’d fill his administration with true believers, not traditional Republican officials recommended by people like Mike Pence.
I have no idea how things would actually play out.
If you wish to argue that Trump would increase inflation, in the sense that economists define inflation, the strongest argument is that the budget imbalance would become even more severe (and it’s already gotten much worse in the past few years), and that this would trigger “fiscal dominance” over monetary policy. I still think we are far from fiscal dominance, but in the very long run it’s a concern if the budget situation is not addressed.
PS. To follow up on a recent post, there are already rumors that Javier Milei is backing away from his dollarization pledge—but nothing I’ve seen is definitive.
PPS. See if this helps:
1. Trump would not make inflation worse. (cost of living)
2. Trump would make “inflation” worse. (standard of living)