Why Investors Want Higher Inflation

Fight disinformation: Sign up for the free Mother Jones Daily newsletter and follow the news that matters.

I’m back. But I’ve been busy catching up on crossword puzzles this morning, and either this week’s puzzles were harder than usual or else my brain is slowly decaying, because they took me a while to finish. Probably the latter.

And speaking of brain decay, before I left I posted a chart showing that, starting in 2008, inflation expectations suddenly started to correlate really well with stock market prices. Scott Sumner and Paul Krugman say this demonstrates that our sluggish economy is due to a slowdown in aggregate demand, and although I’m happy to believe this, it wasn’t clear to me why this correlation had anything to do with aggregate demand. So I asked for help.

Unfortunately, two posts were waiting for me when I got home, each disagreeing with the other. Here’s a nickel summary:

Kash: Normally, high inflation leads to high corporate profits, which makes investors happy. But they also realize that high inflation will cause the Fed to raise interest rates and this will slow growth. So they’re also unhappy, and these two reactions cancel out. However, when interest rates are at zero and the Fed has made it clear they aren’t going to raise them, there’s nothing to be afraid of. So higher inflation is a purely good thing, and therefore high inflation expectations lead to high stock market growth.

In other words, this doesn’t have anything to do with aggregate demand. It’s merely a reaction to the fact that interest rates are at zero and everyone knows they aren’t going up anytime soon.

Karl Smith: Normally, inflation expectations are just inflation expectations. They don’t really affect the underlying productive capacity of the economy, so investors react neutrally. However, in 2008 the stock market suddenly started reacting positively to inflation expectations. Why? If it wasn’t because anyone thought it would affect the underlying capacity of the economy, it must have been a reaction to the Fed’s announcement that it planned to print more money — and the only effect of printing more money is to induce people to buy more stuff.

In other words, investors were convinced that the economy’s problem was a lack of demand, and printing more money (and therefore causing more inflation) would increase demand and fix things up. So whenever inflation went up, the stock market went up.

I score this one for Karl. Kash’s explanation seems incomplete: After all, if investors think high inflation will genuinely lead to high corporate profits, not just a rise in the overall price level, they must think those profits are going to come from increased consumer demand for the stuff corporations are making. So they must be associating inflation with increased demand.

Plus Karl frames his answer in the form of an amusing Socratic dialog, so he gets points for that too. In any case, I’ve linked to both arguments, so you can read them for yourself. Like Glenn Beck, I insist that you do your own homework and not take my word for anything.

AN IMPORTANT UPDATE

We’re falling behind our online fundraising goals and we can’t sustain coming up short on donations month after month. Perhaps you’ve heard? It is impossibly hard in the news business right now, with layoffs intensifying and fancy new startups and funding going kaput.

The crisis facing journalism and democracy isn’t going away anytime soon. And neither is Mother Jones, our readers, or our unique way of doing in-depth reporting that exists to bring about change.

Which is exactly why, despite the challenges we face, we just took a big gulp and joined forces with the Center for Investigative Reporting, a team of ace journalists who create the amazing podcast and public radio show Reveal.

If you can part with even just a few bucks, please help us pick up the pace of donations. We simply can’t afford to keep falling behind on our fundraising targets month after month.

Editor-in-Chief Clara Jeffery said it well to our team recently, and that team 100 percent includes readers like you who make it all possible: “This is a year to prove that we can pull off this merger, grow our audiences and impact, attract more funding and keep growing. More broadly, it’s a year when the very future of both journalism and democracy is on the line. We have to go for every important story, every reader/listener/viewer, and leave it all on the field. I’m very proud of all the hard work that’s gotten us to this moment, and confident that we can meet it.”

Let’s do this. If you can right now, please support Mother Jones and investigative journalism with an urgently needed donation today.

payment methods

AN IMPORTANT UPDATE

We’re falling behind our online fundraising goals and we can’t sustain coming up short on donations month after month. Perhaps you’ve heard? It is impossibly hard in the news business right now, with layoffs intensifying and fancy new startups and funding going kaput.

The crisis facing journalism and democracy isn’t going away anytime soon. And neither is Mother Jones, our readers, or our unique way of doing in-depth reporting that exists to bring about change.

Which is exactly why, despite the challenges we face, we just took a big gulp and joined forces with the Center for Investigative Reporting, a team of ace journalists who create the amazing podcast and public radio show Reveal.

If you can part with even just a few bucks, please help us pick up the pace of donations. We simply can’t afford to keep falling behind on our fundraising targets month after month.

Editor-in-Chief Clara Jeffery said it well to our team recently, and that team 100 percent includes readers like you who make it all possible: “This is a year to prove that we can pull off this merger, grow our audiences and impact, attract more funding and keep growing. More broadly, it’s a year when the very future of both journalism and democracy is on the line. We have to go for every important story, every reader/listener/viewer, and leave it all on the field. I’m very proud of all the hard work that’s gotten us to this moment, and confident that we can meet it.”

Let’s do this. If you can right now, please support Mother Jones and investigative journalism with an urgently needed donation today.

payment methods

We Recommend

Latest

Sign up for our free newsletter

Subscribe to the Mother Jones Daily to have our top stories delivered directly to your inbox.

Get our award-winning magazine

Save big on a full year of investigations, ideas, and insights.

Subscribe

Support our journalism

Help Mother Jones' reporters dig deep with a tax-deductible donation.

Donate