Democracy in America | Inflation

Inflation and renewable energy

Yet another reason why America should reduce its consumption of oil

By M.S.

GLENN BECK types who warn of a coming bout of inflation typically blame it on the policies (or, often, the very existence) of the Fed, which has dramatically expanded the money supply over the past two years to counteract the fall in commercial activity due to deleveraging from the financial crisis, thereby probably preventing a second Great Depression. Fortunately, Ben Bernanke apparently pays no attention to such people. But in a post on Friday, Gavyn Davies explained where the real inflationary threat lies: the possibility that the current rise in commodity prices isn't your typical short-term fluctuation, but part of a long-term trend. As emerging markets grow richer and drive up demand for raw materials, those materials may be rising in value relative to the industrial and service products of the developed economies.

There is a very big difference between a self-reversing up-and-down cycle in the commodity markets, and a longer term upward trend in commodity prices relative to the prices of goods and services produced in the developed economies. Because commodity prices are determined in competitive markets which need to clear at any point in time, they tend to fluctuate much more over short periods than the “sticky” prices and wages which exist in developed economies. If they are simply fluctuating around a constant or slowly rising trend, then they will quickly self-correct and the central bank should stay focused on the core inflation rate which is set in the rest of the economy.

But what if commodity prices are instead embarked on a long term uptrend against the prices of goods and services in the developed economies, driven by the rapid growth in the emerging economies? In that case, the commodity price shock would have a permanent effect on input prices in the developed economies, and it would not be appropriate for the central banks to ignore this shock. In fact, if they ignored it, they would simply be accommodating a permanent inflation shock to the system, which is what they did in the inflationary 1970s.

So it is a very difficult judgment. My own view, based on the arguments above, is that the central banks are justified in waiting for more data before concluding that the rise in commodity prices is permanent.

Paul Krugman likes Mr Davies's column but thinks the main problem is still overreaction to commodity-price fluctuations rather than the reverse. He recalls the point in mid-2008 when the European Central Bank, looking at rising headline inflation that was driven by the commodity bump, made the mistake of raising rates at the onset of a huge recession.

To me, the main point here is just how crucial it is for Western economies, and particularly the United States, to reduce their use of commodities, and particularly oil. The capacities of human ingenuity are limitless; the amount of crude oil on planet Earth is not. If you build an economy that's entirely dependent on a non-renewable resource, you are guaranteeing yourself a nasty encounter with stagflation sooner or later when the stuff starts to run out. The idea that sustainable-resource use and renewable energy is some kind of socialist hippy hobby is incredibly naive and frivolous, and extremely damaging to the American economy.

Discover more

The fifth Democratic primary debate showed that a cull is overdue

Thinning out the field of Democrats could focus minds on the way to Iowa’s caucuses

The election for Kentucky’s governor will be a referendum on Donald Trump

Matt Bevin, the unpopular incumbent, hopes to survive a formidable challenge by aligning himself with the president


A state court blocks North Carolina’s Republican-friendly map

The gerrymandering fix could help Democrats keep the House in 2020