I'm in the process of watching Mark Thoma's online lectures on the history of economic thought. I've only made it through the first two, but in the beginning of the second lecture Thoma brings up what for him is a puzzle.
He discusses the so-called "price revolution" where inflation spiked. It didn't really spike in our modern sense, being only a few percent inflation over more than a hundred years. However, given that nominal growth at the time was also only a few percent (or less), this is significant.
The inflation is typically explained by an influx of gold from outside Europe. Thoma asks: Why didn't that inflation drive up the cost of subsistence at the same rate it drove up output prices? I think I have a pretty good picture of why, but first let's start with some equilibrium analysis (this is in the draft paper).
If we have ideal information transfer (information equilibrium), we can say in the market P : N ⇄ M (price level as the detector of information flow between aggregate demand and money supply) the following two relations hold:
N ~ Mᵏ
P ~ k Mᵏ⁻¹
Let's say M grows at some rate μ so that M ~ exp(μt). Then, if ν is the nominal output (aggregate demand) growth rate and π is the inflation rate (growth rate of the price level), then
ν/π ~ k/(k-1) ≈ 1 for k >> 1
so ν ≈ π. That is to say nominal growth is roughly equal to inflation for k >> 1 (and real growth is small). That is basically Thoma's point above.
This neglects something very important, however. Or, more accurately, we assume something we shouldn't. Thoma naturally translates the modern concept of equilibrium back into the past, but there is no particular reason we should do so. And there is definitely no reason to use information equilibrium.
Here's a picture of what could be happening to the price level:
The equilibrium analysis is the black line and a real economy near equilibrium might behave like the green line. But what we're seeing in the 1400-1500s in Europe is an initial rise of macroeconomies -- the yellow line -- and the transition from non-ideal information transfer to ideal. The influx of money makes information transfer more ideal. The observed inflation rate π in the transition region does not come from an equilibrium analysis so it not only doesn't have to have any specific relationship with ν, the associated "real rate of growth" derived from the two measures is not a theoretically valid concept.
Subsistence goods likely had markets with more ideal information transfer than other output goods (because they were traded more regularly), so the inflation (actually, a movement toward ideal markets) would be concentrated among things besides e.g. food.
Thus the inflation associated with the rise of the first quasi-modern European nation-states with quasi-modern macroeconomies need not be associated with zero real growth. Actually, a pretty good analogy is emergence from a deep depression via monetary policy.
Thumbs up, though I can't know if you got the history right..or at least refuse to knowReplyDelete
What -- a liberal economics professor in Eugene, Oregon not quite close enough to John Cochrane for you?Delete
Cochrane is the most perfect person in all of creation...sorry...Delete
Thanks, Jason. I was reading about the Great Price Inflation (or Revolution) just the other day, and was wondering what you might say about it? There must be some kind of Berkeley psychic connection, eh? ;)ReplyDelete
I took a look at Thoma's talk, and I have a quick answer to his puzzle. His premise that wages were at subsistence level to start with is false. That is obvious, but there is a historical reason: the Black Death of the previous century. Even if wages were at subsistence level in Europe in the early 14th century, the Black Death in the middle of the century wiped out 1/3 to 1/2 of the labor force. The price of labor rose immediately. If workers did not like wages they were offered, they could vote with their feet, instead of being tied to the land, as they had been before.
To give an indication of the reduction in real wages during that time, here are a couple of figures from "Caliban and the Witch" by Silvia Federici (source: B. H. Slicher van Bath, The Agrarian History of Western Europe A.D. 650-1800 (London: Edward Arnold, 1963).) In the early 15th century the average daily wage of a English carpenter was worth 155.1 kilograms of grain; 200 years later it was worth 48.3 kilograms. These are the high and low figures. The median between 1350 and 1800 is 94.6 kilograms. As a skilled laborer, a carpenter would earn better than subsistence wages, but a drop in real wages of more than 50% in the 100 years after the discovery of America is substantial. (BTW, by 1500 the European population had recovered from the Black Death, so increasing population was not much of a factor at that point. In fact, transportation and colonization provided relief from population pressure.)
Now, 1-2% inflation in not much in modern terms, but at the time it was a concern. It could easily have been worse. The amount of gold and silver flooding the Old World from the New was enormous. Had it stayed in Europe there would have been a real problem with maintaining the value of gold and silver coins. However, there was a great demand for it for ornamental, not monetary, purposes in China and moreso in India, and most of it ended up there. The European traders skimmed off the top of the flow.
As for the decline in real wages in Europe, the fact that the Spanish and Portuguese enslaved American natives and stole their gold and silver may well have been a factor. In addition, European governments had instituted repression of wages in various ways in reaction against the rise in wages after the Black Death. Inflation may have helped that repression by masking it in nominal terms. "Your wages aren't going down, the price of corn is going up."
Thoma does discuss the black death, and I remember the mechanism from James Burke's Connection series (I think?).Delete
One of the issues that comes up is that if people are living at subsistence levels, a fall in the supply of labor means a fall in the supply of people making food and thus a fall in the supply of food. The "negative supply shock" of the black death should be accompanied by a negative demand shock of the same size, leaving prices unchanged.
At least if you think about it in equilibrium terms ...
"The "negative supply shock" of the black death should be accompanied by a negative demand shock of the same size, leaving prices unchanged."Delete
Except that it didn't. ;)
Yes, you have two things happening:Delete
1. Money (gold) entering the system
2. Black death
A. At subsistence, 1 should raise the price of subsistence along with the price of everything else, leading to no net growth.
B. Also at subsistence, 2 should lead to a fall in demand roughly equal to the fall in supply, leaving no net growth.
The mechanism of the post above says that 1 need not lead to A. But there is no (immediately obvious) reason to doubt 2 leading to B.
Oh, a comment on the Wikipedia page about the Price Revolution. It states that the population of England in 1500 was half that in 1300. Really? If the Black Death wiped out half of the population in 1347-1350, why didn't it recover at all in 150 years? You've got to be kidding.ReplyDelete
One thing that happened after the Black Death is that a lot of English landowners turned from growing crops to growing sheep, as it is much less labor intensive. So to get the same population pressure required less people than before.
There are other estimates more at the 20-30% range for England, but France really did lose half their population from a combination of the black death and the hundred years' war ...Delete
Thoma does mention the sheep. It's part of what moved people into towns ...