day to the next, hundreds of thousands of lives were at stake and our economic systems came to a halt as governments around the world entered into unprecedented shutdowns.
In the wake of the COVID‐19 crisis, we witnessed a lot of speculation about global economies slipping into recession. This, in turn, was expected to lead to a deflationary environment driven by weakening growth and demand. As a result of the crisis, we witnessed short‐term price fluctuations in stock and bond markets all over the world.
However, the argument of this book is focused on the longer term trends regarding the rise and fall of economies and market.
I believe we have been putting too much weight on inflation statistics which are for a variety of reasons faulty. Despite economic slowdowns – caused by various crises over the years – advances in technology and automation are leading to continuously falling costs for goods and services. At the same time, a wave of completely new products enters the consumer stage every year, improving lives around the world. On example of how technology is reducing costs is the conference call service provided by Zoom Communications; users of their conference app dramatically increased from 10 million per day in December of 2019 to 300 million per day by April 2020. Many of these new users were using the free Zoom version, as opposed to the premium one, so paying nothing for a service that would have cost hundreds if not thousands of dollars in telephone bills just 10 or 20 years previously. To accurately depict this phenomenon of constant technological innovation in inflation statistics is at best challenging, if not impossible, as this book will show.
Another argument of this book is that the “basket” of goods and services which forms the basis of the CPI (Consumer Price Index) calculation is continuously changing, so the basket of 1900 is different from the one in 1950, and the one in 1950 is different from the one in 2000. The problem is that you are comparing different baskets of goods and services, thus rendering any comparison somewhat meaningless. Furthermore, with consumption patterns constantly changing, the basket is always a step behind when it comes to tracking “typical” spending patterns.
Over the years we have seen far‐reaching changes in the way people work, shop, and spend their time. This in turn has led to significant changes in spending patterns and, in some cases, rapid price changes. Certain goods have disappeared from shelves and many services are no longer provided. So, calculations based on the “old” basket no longer reflect changes in the consumer welfare of a “typical” person, as typical consumer behavior has changed.
If inflation statistics do not accurately reflect the changes in peoples' welfare, then it does not make sense to stick to inflation targets. By 2020, central banks were learning this the hard way as their financial tools were proving less and less effective in influencing inflation numbers. What we need to recognize is the necessity of questioning the holy grail of inflation targeting and rethinking an approach that we have been following almost blindly for a long time.
This book aims to help unravel the Myth of Inflation and to provide some food for thought on the future of the inflation policies that are significantly impacting our everyday lives around the world. More importantly I want to demonstrate that, in fact, we are in a deflationary world with goods and services improving in quality and variety while declining as a percent of people's incomes.
INTRODUCTION
Inflation has been a subject for bankers, scholars, political leaders, and the general public for a long time. The rising prices of goods and services in currency terms have been condemned by people since time immemorial. There has been no let‐up in everyone's desire to stop prices from rising, despite governments' continual actions to debase their currencies.
Very often governments, yielding to popular pressure, have taken draconian measures – such as prohibiting price rises and punishing those who disobeyed. In 1971, President Nixon announced a freeze on all prices and wages throughout the United States. Gerald Ford, his successor, distributed buttons with the slogan “whip inflation now.” Presidential candidate Ronald Reagan announced that inflation was “as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man.”
In early 2020, it seemed that the tables had turned. Central bankers and economists were worrying that inflation was disappearing and we might even have been in a deflationary era. And despite their efforts to bring inflation up, as they believed that an inflation rate of at least 2% would render economies healthy and result in economic growth, their cures did not work. Dramatic decreases in interest rates and “quantitative easing” – or money printing, with central banks buying bonds and even stocks (as in the case of Japan) to feed money into the system – failed.
But why were recognized theories not working anymore? For example, the famous Phillips Curve Theory – there is an inverse relationship between inflation and unemployment – did not seem to be valid anymore. Central bankers who promised that job growth would lead to inflation rising were proved wrong. The good news was that central bankers like Mario Draghi, the former head of the European Central Bank, and Mark Carney, governor of the Bank of England, warned that the economic policy consensus was no longer tenable. Jerome Powell, head of the US Federal Reserve, said that inflation was one of the “major challenges of our time”… and he was not referring to too high inflation but to too low. Times had really changed.
The question central banks and governments were asking themselves was what they could do to boost inflation when neither lowering interest rates (by 2020 rates in the major economies were either below 1% or, as in the case of Europe and Japan, negative) nor measures aimed at pumping liquidity into the economies were working.
One of the main reasons behind these shifts in economic practice and theory has been the acceleration of technological progress. It is driving productivity, which in turn lowers the costs of goods and services even as governments devalue their currencies by printing more and more money. Probably the best example of this technology change is Amazon and similar online shopping firms who have pushed retail costs down and decimated many parts of the traditional “offline” retail scene. Studies showed that online prices were falling steadily from 2012 and were lower than they have been at the turn of the millennium. The so‐called “Amazon Effect” was not limited to Amazon. We witnessed the phenomenon in transport (Uber), hotels (trivago.com), and travel (opodo.com). But the decline in prices could be attributed not only to those organizations directly serving the public at the retail level, but also to the producer level – where improvements in automation, workflow programming, and many other innovations were pushing the costs of production down. The invention of cell phones was just the start of the crash in communication prices. Those costs continued their downward trend with the invention of internet calling and faster, cheaper smartphones.
Of course, the hapless gatherers of inflation statistics have been in a quandary because of the avalanche of new, innovative, or significantly improved products as a result of technological innovation. This has made the task of measuring inflation an impossible one. A study by economists Austan D. Goolsbee and Peter J. Klenow found that even excluding clothing, 44% of online sales in an Adobe Analytics database were of goods that did not exist the year before! The net entry of new goods alone led to the CPI overstating true inflation by 1.5 to 2.5 percentage points per year. They also found that online prices for bedding and furniture fell by about 12% between January 2014 to June 2019 but the official consumer price index fell by only 2.1%.1
More importantly, the proliferation of free services throws any effort to measure inflation completely out of whack. I now can make a video call anywhere in the world, obtain information on any subject, and translate languages free of charge. Ten years ago, or even five years ago, would it have been free? And how much would those services have cost? Erik Brynjolfsson and his research team at MIT tried to measure the value to users of various free online services by withholding
