The Fed Is All Wrong About Inflation

Rising pessimism: The rising prices of a long price wave have a psychological effect on a society. As inequalities rise, optimism gives way to pessimism. Since price waves are accompanied by increases in violence, family breakups, alcoholism and poverty, there's a growing sense in a society that something is wrong. Could the sense that something has gone wrong in this country that shows up in current opinion polls -- shared by conservatives and liberals, by the devout and the secular -- even if we don't agree on what it is or how to fix it, be an instance of this shift in social psychology?

Finally, crisis: As prices rise, the economy and the society become increasingly stressed until a bit of bad luck that would have been shrugged off earlier leads to a crisis. So, for example, by 1789 a wage-earner in France was spending 88% of his income to feed his family. In the period from 1726 to 1791, it took only 50% of income. So when the harvests failed in 1788 and 1799 and prices soared, as they had done in earlier years of bad harvests, it was enough to tip the country into chaos. Make up your own list of tipping points for today's economy.

Where Fischer Left Off

Fischer's book ends with a discussion of the price wave that began in 1896 and continues today. But the book was published in 1996, so it doesn't discuss the rise of China and India, the U.S. debt bubble or Washington's fiscal crisis. Let me try to add those events to Fischer's framework.

First, adding the 2 billion consumers of China and India to the global economy is our century's equivalent of the population increases that Fischer posits as the cause of earlier price waves. This is a massive increase in global demand, and we're seeing the expected increases in the prices of food, fuel and other basic commodities. And we're seeing the stable of declining prices of manufactured goods that are typical of the first half of price waves.