Price Level Shocks, uhm, Screwed Up Relative Prices, and Organization
| Craig Pirrong |
Peter’s post on the relation between inflation, vertical integration, and markets brings a couple of other thoughts to mind.
First, and most importantly, the number and characteristics of markets are endogenous too, and respond to changes in the amount of uncertainty in the environment, including the amount of uncertainty resulting from monetary shocks that (in Sherwin Rosen’s unforgettable in-class phrase) “f*ck up relative prices.” In particular, the number and variety of futures markets depends on the amount of uncertainty. The big boom in the creation of futures markets in the 1970s corresponds with, and was arguably caused by, the coincident inflation of that period, and the associated volatility in relative prices.
Second, although Peter’s point, and previous research, focuses on the implications of inflation on organizational choices and market vs. firm choices, in the current environment it is worthwhile pondering the implications of deflation. Certainly we have more research on the effect of inflation on the variability of relative prices due to our more recent inflationary experiences, and this was a major source of concern about inflation among Austrians, but the current situation makes it worthwhile to consider the effects of deflation on the pricing system, and firms’ responses to that.
Perhaps an examination of Japanese experience since 1990 would be worth some in-depth analysis.
Personally I am torn as to whether inflation or deflation is the greater risk in the near to medium term. The huge monetary overhang in the US and around the world (resulting from quantitative easing and other extraordinary monetary policies), and the inability of the Fed to commit credibly to drain reserves from the system when money demand picks up make me believe that it will be hard to avoid a burst of inflation. But all current indicators point to flat or declining prices.
It is hard to see things ending in a Goldilocks moment — just right. Thus, it is likely that that there will be a shock to prices generally, arguably a large one, and that this will disrupt relative prices for a variety of reasons. (Including, notably, the very likely case where these price level shocks lead to government policy interventions that distort relative prices.)
Thus, Peter’s research program may be rejuvenated, courtesy of the Fed, ECB, the Chinese Central Bank, etc. It is indeed an ill wind that blows nobody any good.