As readers of this blog probably know, I’m not averse to some inflation. In fact, I think it pretty well nigh on essential that successful economies embrace some inflation, and probably a little higher than the UK has had for some time. It seems to make that this is the only way to ensure debts are repaid without too much pain, wealth is passed appropriately between generations, and that the environment in which investment will occur exists.
I am also aware that many consider this heresy and little short of a hanging offence, so it was pleasing to see Dean Baker coming out strongly in support of the same idea in this blog, which I reproduce in full, without apology:
Keynes quipped in the General Theory that the world is ruled by the ideas of long dead economists. I was reminded of this comment when I heard a member of Germany’s parliament scornfully dismiss the suggestion that the European Central Bank should target a somewhat higher rate of inflation. This suggestion had been put forward by Oliver Blanchard, one of the world’s leading macroeconomists. Furthermore, he had proposed a higher inflation target in his role as the chief economist for the International Monetary Fund.
There is nothing wrong with disagreeing with an economist, no matter how prominent they are or where they work. But what was striking was the nature of the dismissal. The parliamentarian just asserted that: “inflation never solved anything.”
That’s a strong statement. Did he get that information from his parents? Or, as we used to say growing up in Chicago, “Did your momma tell you that?”
Blanchard and others arguing for a higher inflation target actually have very good reasons as to why higher inflation might be very helpful in solving the world economic crisis. First, a higher inflation rate will erode the real value of debt. This will benefit all debtors, households, businesses and countries.
In the case of households, tens of millions of homeowners in the United States and elsewhere have seen much or all of their equity disappear with the collapse of the housing bubble. A modest rate of inflation should begin to lift house prices, restoring equity to these families. It will also reduce the burden of their monthly mortgage payments if wages rise in step with inflation. This will not only be beneficial to these families; a lower debt burden will allow families to spend more, helping to drive the economy.
The same story applies to many businesses that are now facing crushing debt burdens. Furthermore the knowledge the prices of the items they sell will be rising 3-4 percent a year will make investment more attractive to businesses.
Finally, a moderate rate of inflation can go far toward alleviating the debt burden faced by so many countries these days. After 10 years, a 3.0 percent rate of inflation will reduce the real value of a fixed debt by 26 percent; a 4.0 percent inflation rate will reduce it by 34 percent. The modest inflation of the 40s, 50s and 60s was a big factor in bringing down the huge U.S. World War II debt to a manageable level.
Inflation can also be enormously helpful in allowing the euro zone countries with excessive labor costs (e.g. Greece, Portugal and Spain) to get their costs more in line. If wages in more competitive countries keep pace or exceed average euro zone inflation, while wages in the troubled countries don’t rise as rapidly, then they should be able to restore their competitiveness more quickly.
These are the sorts of arguments that Blanchard and others have put forward for allowing a somewhat higher rate of inflation. But the German parliamentarian didn’t care, because he somehow already knew that “inflation never solves anything.”
Policy that rests on unexamined assertions (that emanate from the teachings of long-dead economists) will be every bit as destructive today as it was in the first Great Depression. In Europe, this drama seems to be playing out in the desire to really make Greece feel pain. Greece undoubtedly has to straighten out its fiscal mess. (Is there some reason that everyone is not pushing a tax amnesty program as a way to reduce the Greek debt and show that it is serious about ending wholesale tax evasion?) However, it can’t be expected to balance its budget in the middle of the worst downturn in 70 years.
The same applies to Portugal, Spain and other troubled European economies. Contractionary moves by these governments will worsen the downturn in these countries and in fact, make matters worse in the sound finance countries as well. Fewer imports in Spain and Greece mean fewer exports for Germany and France. Furthermore, enough downward pressure on these economies will likely require a debt restructuring at some point anyhow. The debt burden grows when economies shrink and that seems to be the plan coming from the economic center of Europe.
There might be some justice in the fact that the austerity plans designed by Germany will come back to bite them, but it would be much better to see the Germans design good economic policy. There was perhaps an excuse for bad policy in the 30s; after all Keynes didn’t publish the General Theory until 1937. But, there is no excuse today — the ideas of Keynes have long been known and widely disseminated. It is a tragedy and an outrage that the people deciding economic policy are mindlessly repeating tired clich?©s rather than seriously trying to design policies that address the crisis in front of our faces.
This is good Keynesian economics — the sort we need now, and which the EU needs to embrace very quickly if the Euro is to save and the European ideal — which has prevented war for more than 60 years — is to be saved.
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Richard, I’ve just read this on the Real-World Economics Review Blog. Whilst I totally agree with what you have written, I am very perturbed at Baker’s quote ‘A modest rate of inflation should begin to lift house prices, restoring equity to these families’. I have just posted my response.
“It will also reduce the burden of their monthly mortgage payments if wages rise in step with inflation.”
That is the trick isn’t it? No big deal in the case of Government workers, but a potential big problem in the case of those employed by private business, given that the recession has killed revenue growth and the Government has passed new mandates (such as health care) that are raising the costs of employing their staff.
“This will benefit all debtors, households, businesses and countries.”
Plainly untrue. It doesn’t benefit creditors, whether they are bondholders in corporate/government debt or household savers (mostly older people who have to see out their days on their nest egg). The capital buys less than it would have done if there had been no inflation. Real people are worse off.
And one thing we know about inflation is that it is redistributive. Good for holders of debt (as the value of the debt erodes). OK for people who can adjust their incomes — business owners etc. Bad for savers, bad for pensioners, bad for wage earners whose pensions/wages won’t move as quickly as prices change.
This is high school level economics so I don’t think I am saying anything too profound here.
I agree that low inflation is better than high inflation, but if you find the redistributions described above to be a bad thing, then why want any inflation at all?
Obviously, if you don’t have a problem with those redistributions (and the other problems inflation brings, such as distortions), then inflate away! As a small business owner myself, with debts over the home + a couple of investment properties, from a selfish perspective, I would just love a bit of inflation just now.
However, I don’t think it would be particularly good for the groups outlined above, and therefore overall I don’t think it is a good thing.
@Adrian
You have made a choice, that a minority – savers, the old, fixed income pensioners (a decided minority of all pensioners) are more important than the young, business, investment and so on.
You have made a value judgement.
So have I.
I contend mine is a better value judgement.
All economics is about subjective matters.
It is never value free, despite the claims of some
Richard
Richard
In your list of the ‘minority’ you missed one group out that I did mention (and which Fred also referred to above): wage earners. Do you regard them as a ‘minority’? Whether they are young or old makes no difference – if prices go up faster than their wages, they will be worse off.
The thing with fixed wages is: they are slow to change. Maybe once or twice a year, if that (if the boss can afford them which is a big if). And often after the inflation has already occurred, and it is hit and miss about whether the wage increase is even enough, or even properly covers the purchases of the individual wage earner (which may differ from the basket used to calculate the inflation).
Keynes advocated inflation as he was well aware that wages were ‘sticky’ due to collective wage bargaining, and inflation offered a ‘painless’ way to reduce the real burden of wages on the economy during downturns.
Doesn’t this use of inflation to intentionally seek to defraud workers into accepting real salary decreases strike you as bad? Isn’t inflation essentially a way that certain sections of society (low earners, pensioners, government workers) are forced to pay for other sections of society (City banks and massively leveraged private equity funds)?
@Adrian
Wage earners are not a minority
But there is no indication that with moderate inflation there is any real likelihood of most losing out
Strong unions help, of course
@James Tyler
Of course wages are sticky
But as I note, given moderate inflation and good collective bargaining I think few would lose out
Certainly this is vastly better option than massive cuts in public services and mass unemployment
That’s the alternative
And you might like to suggest how that helps most wage earners?
Oh, and banks lose from inflation – they borrow short and lend long. the long lend depreciates in value
The short borrow relatively less so due to it being recycled
As you rightly suggest Richard, one other group to greatly benefit from inflation are the trade unions. More for them to do, more frequent wage negotiations with more at stake, more disputes to handle, easier to convince workers to join.
I would have regarded this as an overall cost, making us all (not the least, union members who have to pay for it) worse off. And not to mention the industrial unrest that can’t be good for anyone.
Adrian
You mean paying people what they’re worth is something you resent?
But exploiting them is something you think worthwhile?
Hard to justify, don’t you think?
Richard
So the central bank, buying gilts, then crediting the banks with newly printed reserves, which the banks can then lend out again, and again, and again does not help the banks make profits? Where do those profits come from? Debased money – reduced purchasing power. Whose reduced purchasing power?
Somebody has to pay somewhere? It’s not magic…
What would help average wage earners is wealth creation, not secret wealth reallocation.
James
But right now those you call wealth creators have severely screwed up
And they’re sure not wealth creating enough
That’s what a recession is. Maybe you haven’t noticed.
So the mess has to be cleared up to ensure the right environemnt for wealth creation exists again
One way to do that is to restore equilibrium in the value of assets and wages
That does not exist right now
Wage inflation can restore it
And at the same time give incentive to invest in wealth creation and not in saving – something very. very different
“You mean paying people what they’re worth is something you resent?”
Negotiations about inflation-based pay rises are never about what people are ‘worth’ (an interesting but unrelated topic) but about preserving living standards. If they were about ‘worth’ everyone would get something different. Inflation based pay rises is generally about giving everyone the same.
If we have zero inflation, we can be pretty sure we will preserve living standards for wage earners. Bob the Worker on £20k gets as much for his £ this year as last year. He may not be going forwards, but at least he isn’t going backwards. No need for unions to negotiate a pay rise every few months just to keep him treading water. He may need unions for other things, but this arduous task of unions is eliminated, thereby resulting in a) cheaper union dues for Bob b) freeing up the boys and girls who work there to do something else more productive, whether within the union or otherwise c) less management time tied up in negotiations and d) less stress and strife that accompanies all this. Also Bob isn’t relying on the union agreeing to a rate of increase that bears little resemblance to his actual expenditure. Winners all round in my book.
If we have inflation but rely on unions to preserve living standards, we have the opposite of the above — added cost to Bob, resources tied up for unions and management in regular negotiations (and they do have to happen regularly to maintain living standards), more stress and strife. And there is no guarantee Bob’s living standards really will be sufficiently preserved according to his own expenditure — anything the union agrees on his behalf is at best, hit & miss.
Unions have their place — but inflation would just create significant and avoidable work for them that benefits nobody but the unions.
@Adrian
This is nonsense and I’m sure you know it
You’re living in the make believe world of marginal economics
Out in the real world employers (me in my time) like unions because it’s a lot easier and cheaper to engage in collective bargaining than individual bargaining
And the reality is zero inflation slips easily into deflation and then into recession and so into depression so the world you desire is profoundly destructive
So inflation causes a little cost
The benefits massively outweigh them
Except for economic fantasists and those libertarians who think liberty is decidedly asymmetric
You are so right, Richard. The returns to capital and land have squeezed wages so far that there is insufficient demand in the economy to soak up all the dosh that has been floating about.
Richard,
Your entire post has been the desirability of inflation.
I have said less is better than more, and none is better than some.
I dont have a problem with unions or collective bargaining. I accept that logic and have been there myself. However, the higher the inflation, the more often you need to discuss on the issue of inflation alone (assuming maintaining living standards is important). Leaving management, unions, and staff distracted when they have better things to do.
If there is no inflation, that’s one less thing to think about and living standards are preserved.
“So inflation causes a little cost”
Have you ever tried to live on a low, fixed income during inflationary times? The effects are real, and are unfairly distributed in my opinion. And relying on unions is at best, patchy and only for some.
Which wealth creators: the banks? Goldman Sachs? What wealth do they ever create – borrowing from the Fed at 0.25% and then punting it on the global finance casino?
Barclays bank? Takes your £100 of your Tesco money, multiplies it up 10x and invests a £1000 in Alphabet Soup derivatives. And you want to facilitate this? Because the uncertainty that inflation creates allows finance traders to do this.
The wealth creators are those who take the factors of production and reorganise them more efficiently – not banks. The sooner we can start to support these guys, the better.
How can the inflation tax clean up the mess? It rewards those people who created the mess….
Richard,
The whole idea of inflating debts out of the system is revolting, but I am like you of the view that it is the lesser of several evils. Unfortunately, we have reached a situation where it is in the self-interest of the virtuous (savers) to rescue the frivolous (borrowers) so as to not risk a collapse of the entire system.
However, one of the problem is that for this strategy to work, one has to assume that real interest rates remain negative or at least neutral. It is difficult to see this happening, at least for the long-end of the treasury and credit curves.
Out of interest, what is your definition of a “moderate” level of inflation. Is it somewhere between 4% and 6%, or higher?
@Ted G
5% rather than 2.5% would be fine as a target right now
More – I agree would be unwise
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