February 26, 2016
The confusion on inflation continues. The NYT ran a Reuters piece on the latest inflation data from Japan. The piece began by telling readers:
“Japan’s core consumer prices were unchanged in January from a year earlier, suggesting that persistent falls in energy costs will keep inflation well below the central bank’s 2 percent target.
“While falling fuel costs may be a boon for corporate profits, low energy prices suppress inflation which in turn may discourage companies from raising wages or the prices of their goods.”
Okay, let’s step back a second. The reason that folks care about having higher inflation is to give firms more incentive to invest. If the goods and services they are selling rise in price by 2.0 percent a year, as opposed to staying flat, then they have more incentive to invest at the same nominal interest rate. We’ll call this 2.0 percent inflation case “Scenario I.”
Now let’s imagine Scenario II. Suppose that the prices of the goods and services firms in Japan produce rise by 2.0 percent a year, as in Scenario I, but the prices of oil and other items that Japan imports fall rapidly. The result is that the overall inflation rate is zero.
Your brainteaser for tonight is: do Japanese firms have any less incentive to invest in the Scenario II than Scenario I?
Addendum
I should mention that cheap oil is horrible for the environment since it encourages people to use more of the stuff and makes it more difficult to promote clean energy. This may be obvious, but is worth repeating.
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