Did central bankers get it wrong?

Albert Wenger of Union Square Ventures published a new article arguing that GDP is the wrong KPI we should use because many goods and services have become “free” thanks to tech development and that productivity gain is GDP-negative (think about a smart phone as a substitute for many other devices which cost a lot more combined). In his recent articles, he also mentioned education and healthcare as great examples. He also quoted Marc Andreessen who on his tweetstorm argued about the “Secular Stagnation” topic.

This reminds me of my recent article inspired by another post from Albert. My argument for GDP as the wrong economic indicator was that the sampling method and data sources are outdated. But Albert’s new article gave me another reason, as technological advancement is price deflationary and output-negative.

If so, shouldn’t the long-term natural inflation (and inflation expectation) also be negative? Intuitively, we can think about an iPhone 5s used to cost a lot more before the iPhone 6 is released. Even if you ignore the version difference and only look at iPhone’s price, it should at most stay the same, instead of having an inflation.

Modern monetary policy is conducted by central banks and all currencies are fiat currencies nowadays, meaning they are not backed by any physical asset but only on central bank’s credibility. And one of their main argument of keeping inflation moderate but positive is that such a inflation rate is low enough to avoid social tensions while high enough to stimulate expenditure and investment.

In a static world, the more money printed, with the amount of goods and services fixed (and themselves fixed, of course), the prices of these goods and services would be higher, thus inflation. This will stimulate producers to supply more goods and services, and they need more money (printed by central bank) in the production.

But with technological development, the situation is different. So many production procedures can be free/less costly. For example, funding for production is cheaper thanks to more VCs and crowd-funding. You can lease instead of own machinery and equipment for production (or use the internet-based model like Xiaomi). Marketing and sales have become much cheaper and more effective too, thanks to the internet and Google/Alibaba. As a result, it would make sense for the end-product to be cheaper, at least from the cost perspective. As for services, the prices can go virtually to zero — I’m using Duolingo everyday to learn French, and I’ve used free content on Google/Youtube to learn Google Analytics.

Our productivity has become a lot higher with new devices and new knowledge that cost a lot less, and this doesn’t seem to give producers disincentive to supply more and better goods/services. Did the central bankers get it wrong?

Central banks emerged serving the purpose of providing stability to the financial system (the history of J.P.Morgan), and major central banks got rid of the gold-standard fairly recently (the collapse of Bretton Woods) to gain sovereign power to conduct monetary policy and to balance full-employment and growth.

However, central banks’ policy and financial regulation were the exact reasons behind the financial crises and it is proved that, in the long run, their policy has no effect on potential growth and employment, if their assessment is ever correct. We brought in a tiger to fight the wolf, now the wolf is gone but the tiger is more dangerous.

Maybe, after so many financial crises in history, it’s time to bring in something else to fight the tiger. Although we can’t guarantee its success, at least it’s better than being doomed to die with the tiger. This new thing might be cryptocurrency/blockchain.

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