Unbeknownst to most Americans, there is an argument raging among economists and politicos over whether the United States needs "just a little inflation" to jump-start the economy. Those on the liberal side of the fence want an activist Fed to create an inflation target of about 4-5% and set in motion monetary policies to get us there. (Print more money, and make sure it circulates in the economy.) Those on the other side think that's crazy. So do I.
For the record, here is the official CPI as of the end of July.
From Tim Iacono. The CPI, including "volatile" food & energy costs. Overall prices were 3.6 percent higher than a year ago through July, 2011.
Ken Rogoff got the ball rolling in an editorial in the Financial Times ($ubscription) when he said—
If direct approaches to debt reduction are ruled out by political obstacles, there is still the option of trying to achieve some modest deleveraging through moderate inflation of, say, 4 to 6 per cent for several years. Any inflation above 2 per cent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures. Ideally, both the ECB and the Fed would engage in expansionary policy...
Floyd Norris of the New York Times followed-up in support of Rogoff in Sometimes Inflation Is Not Evil. Others have weighed in lately, including Paul Krugman's When Inflation Was Good and Kevin Drum's A Little Inflation Can Be A Wonderful Thing. (Drum writes for Mother Jones.) Inflating our way out of debt is not a new idea. There are many historical examples, including the post-World War II episode cited by Krugman. (Somebody needs to remind Krugman that the world is not at all like it was after World War II.) The title of Drum's article was crafted as a response to Paul Volcker's A Little Inflation Can Be A Dangerous Thing, from which I quote—
There is also a sense of desperation that both monetary and fiscal policy have almost exhausted their potential, given the size of the fiscal deficits and the already extremely low level of interest rates.
So now we are beginning to hear murmurings about the possible invigorating effects of “just a little inflation.” Perhaps 4 or 5 percent a year would be just the thing to deal with the overhang of debt and encourage the “animal spirits” of business, or so the argument goes...
The siren song is both alluring and predictable. Economic circumstances and the limitations on orthodox policies are indeed frustrating. After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations — as the Fed and most central banks believe — why not 3 or 4 or even more? Let’s try to get business to jump the gun and invest now in the expectation of higher prices later, and raise housing prices (presumably commodities and gold, too) and maybe wages will follow. If the dollar is weakened, that’s a good thing; it might even help close the trade deficit. And of course, as soon as the economy expands sufficiently, we will promptly return to price stability.
Well, good luck.
Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth.
My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.
I'm with Volcker. Unequivocally. I used to be a liberal, but I'm not any more. I'm not anything now.
Don't you find it outrageous that liberal economists—you know, the ones who supposedly care about us—want to crucify savers and those on fixed incomes? They argue that the stimulus provided by the inflation would somehow make up for this outrage. But the potential damage "just a little inflation" might do is far worse than that. Did you catch the key phrase in Volcker's rebuttal? Maybe wages will follow. About 60% of Americans have not had a raise (in real, inflation-adjusted terms) in three decades. Their wages have been basically frozen all that time. And now these heartless assholes want to further destroy the purchasing power of those wages. I first used this graph in my post America's Invisible Poor.
From Lane Kenworthy's The Best Inequality Graph. "Between the late 1940s and the mid-1970s incomes increased at roughly the same pace throughout the distribution; they doubled for each group. Since the 1970s the story has been quite different. At the 95th percentile, incomes have continued to rise. At the upper-middle levels (the 80th and 60th percentiles), they’ve increased at a moderate pace. In the bottom half of the distribution (the 40th and 20th percentiles), they’ve been fairly stagnant."
It's bad enough that inflation, as measured by the CPI, if you include energy and food, currently stands at 3.6% on an annualized basis (first graph above). Those favoring "just a little inflation" are talking about "core" inflation, which discounts energy and food. As Volcker notes, 4-5% "core" inflation would no doubt drive up commodity prices beyond the rising levels we've seen over the last year.
More importantly, there are various long term downward pressures on wages in the United States unless you're near the top of the income scale. I think it highly unlikely that we would see any wage gains in the middle or at the bottom of that scale if the Fed created "just a little inflation." Wages for these workers have been stagnant for three decades. Why would that change now? There would thus be no possibility of a rising wage & price spiral because wages would not budge as prices skyrocket. As Volcker says, a very destructive stagflation worse than that we're experiencing now is by far the most likely outcome.
So what's the solution Krugman, Drum and other so-called "liberals" are offering up to save the economy? I think this quote from the Vietnam War sums it up perfectly.
"It became necessary to destroy the village in order to save it."
— An American major after the destruction of the Vietnamese Village Ben Tre
My understanding is that Krugman et. al. are willing to take a chance on bringing about stagflation because a deflationary depression would be so much worse. Perhaps it is, but given our overall predicament, it's also pretty much inevitable. Keynesianism worked okay when the economy was flush was possibilities for further growth, but now that resource-constraints and economic-maximization (my own personal term for growth in an industrial economy going about as far as it can) are asserting themselves, all the old solutions be they liberal or conservative are meeting up with the principle of diminishing returns. I think of myself as a nonmainstream liberal, meaning while I have a liberal political temperament, I recognize that you can't have infinite growth on a finite planet.
Posted by: Mr. Roboto | 09/22/2011 at 10:42 AM