When Is A Constraint Not A Constraint?

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Everybody “knows” that there is an inflation “constraint,” but that statement is pretty much the end of what people “know” about it. If you have been paying attention to economics, policy, or even just the prices of stuff, you have heard that monetary and fiscal policy are limited by this inflation constraint. When it comes time for methodological disputation, we are quickly reminded that “everybody knows there is an inflation constraint” with the implication that there is no benefit in thinking about it any further.

If you’ve actually taken an economics degree, you’re familiar with the ideas of linear programming and the production possibilities frontier. They teach in 101 (and 201, and 301, and…) that all it takes for inflation to happen is “output above potential.” How something could happen that could not “potentially” have happened is left to the theologians.

With the last six months of discourse preventing us from leaving well enough alone, honesty requires that we point out both that an inflation constraint exists, but also that everyone knowing this means we need to think about it more, not less. There was no binding inflation constraint in, say, the United States in 2009. If everybody already knows there is an inflation constraint, then everybody believes something false. Sadly, this isn’t even one of those comparatively simple cases where it depends on what the meaning of “is” is.

The logical situation is even worse. When inflation binds - as it did in January 2022 - the symmetric deflation constraint cannot bind. Practical economics seems mired in a double bind: there can be at most be either an inflation or deflation constraint and yet we must constantly take both into account.

The solution is obvious but not simple: there are constraints, constraints and constraints. The Devil take whoever confuses the three. A constraint may be:

1. Active: Small changes in the constraint can change the outcome. 

2. Non-binding: Small changes in the constraint alters the possible outcomes but not the outcome.

3. Redundant: A small change in the constraint alters neither the outcome nor the range of possible outcomes.

Of course, we are using “small change” in the mathematical sense of an open set of shifts.

Active constraints are easy to understand: for want of a horse, the rider was lost, and eventually pereat mundus. It’s the other two that can be tricky. Ever since Schlesinger introduced complementary slackness in 1935, economists have emphasized the importance of non-binding constraints. Complementary slackness, in the language of economic planning, means the planner doesn’t know which goods will need to be produced and which will not until after the plan is made. Contrariwise, nobody emphasizes the importance of redundant constraints, since it seems reasonable to think the planner may be aware there is a lot of land and very little machinery even before planning.

However, this non-emphasis is a mistake for economics in general. As this little note has already begun to dramatize, the inflation or deflation constraint on monetary and fiscal policy is often – technically – redundant. With inflation all around us in the discourse and the world, we will let this little drama of redundant constraints play out within the safe confines of a tiny little static model of inflation.

A Tiny Little Static Model of Inflation