Good Inflation, Bad Inflation

Krugman - NYTimes.com:

FTAlphaville reports that some people believe that surging commodity prices might be good for Japan, because they will make deflation go away.

OK, this is a failure to understand the principle.

Why does deflation have a depressing effect on the economy? Two reasons. First, it reduces money incomes while debt stays the same, so it worsens balance sheet problems, reducing spending. Second, expectations of future deflation mean that any borrowing now will have to be repaid out of smaller wages (if the borrower is a household) or smaller profits (if the borrower is a firm.) So expected future deflation also reduces spending.

So, does a rise in food and energy prices do anything to alleviate these problems? No. In fact, it makes them worse, by reducing purchasing power. So while the commodity surge may temporarily lead to rising headline prices in Japan, the underlying deflation problem won’t be affected at all.

In a way, this is another illustration of the need to differentiate among inflation measures. It’s not exactly the same as the usual case for focusing on core inflation, but it’s related. And once again, the point is that looking at “the” inflation rate is a bad guide for policy.

How Different Bubbles Work

Almost by definition, bubbles are conditions where prices temporarily soar.  A crash is when prices temporarily drop.  The financial "bubble" of 2006-2007 was actually a crash.  The price of money (interest rate) dropped and the mortgage market was awash with so much extra money that they were giving mortgages away to dogs and dead people.  The housing bubble, in turn, was caused by the crash in the cost of borrowing money.  That was a bubble that was caused by an irrational, unsustainable temporary increase in demand for housing fueled by increased borrowing.   This is unsustainable for the same reason that a Ponzi scheme is unsustainable.  Prices can only rise as long as new money keeps flowing in which cannot continue forever.  Current prices are always based on expectations of future prices.  If people think that future prices will go up because of a momentum strategy (what has been going up in the past will likely continue to go up in the future), then that creates an inherent instability in markets. 
Some bubbles are caused by a decrease in supply that are caused by hoarding.  Hoarding creates an unsustainable increase in price unless there really is a permanent decrease in supply.  Amartya Sen argues that this was the main reason for the 1943 famine in the Bangladesh region of British India.

We need better definitions of bubbles.  There are Ponzi-demand bubbles caused by expectations of higher future prices and new money flowing into a market. There are hoarding-supply bubbles caused by suppliers raising their current stocks.  And then there are "bubbles" like the "financial bubble" that are misnamed and are really crashes in price which I will analyze another time and probably have very different causes. 
Krugman dismisses the ability of financial markets to create bubbles if there isn't an increase in stocks, but that only looks at hoarding-supply bubbles and there certainly could be a financial Ponzi bubble that causes a bubble without hoarding.  The problem is in how to measure a financial Ponzi bubble.  The hoarding-supply bubble is easy to measure if we have measures of stocks, but do we have any measures of monetary inflows into markets?  In the short-run supply is very inelastic and too many dollars chasing a nearly fixed supply of anything will raise its price. 

Economic growth & Inequality

Economic growth: Why the rich must get richer | The Economist:

“The value of a rising standard of living lies not just in the concrete improvements it brings to how individuals live but in how it shapes the social, political and ultimately the moral character of a people.” Growing prosperity, history suggests, makes people more tolerant, more willing to settle disputes peacefully, more inclined to favour democracy. Stagnation and economic decline are associated with intolerance, ethnic strife and dictatorship.

It is not obvious that this should be true, so why has this tended in practice to happen? Mr Friedman's explanation is that people's sense of well-being is essentially relative. They become accustomed to any fixed standard of living, rich or poor. They are happiest if they feel their standard of living is rising (something that, in principle, all members of a society can experience at once), or if they feel that they are better off than their peers (which is divisive and not an aspiration that everyone can realise at once).

The key thing is the way these two standards of comparison—the potentially harmonious and the socially self-defeating—interact. If people are becoming better off relative to their own past standard of living, they will care less about where they stand in relation to others. If they are not growing better off relative to their own past standard of living, they will care more about their placing in relation to others—and the result is frustration, intolerance and social friction. Growth, in short, has moral as well as material benefits.