Inflation as a solution

Some economists are suggesting that a cure for our economic woes would be for the government to purposefully create inflation.  Robert Samuelson explains:

The idea now is that the Fed would pump money into the economy until inflation — a rise in most prices, not just erratic gasoline prices — reached a desired level of perhaps 4 percent to 6 percent. Harvard economist Kenneth Rogoff admits the policy is “radical.” He supports it only because he sees the main threat to the U.S. and European recoveries as massive “debt overhangs” of private and governmental debt. “People are retrenching because they realize that high debt makes them vulnerable,” he says.

Inflation is one way to reduce debt burdens. As wages and prices rise, the value of existing debt erodes. Consumers, businesses and governments are liberated to spend more freely.

To be sure, higher inflation represents a wealth transfer to debtors (who repay in cheaper dollars) from creditors (who receive cheaper dollars). That’s unfair, Rogoff says, but it may be less unfair and disruptive than outright defaults by overborrowed debtors.

Faster inflation might boost the economy in other ways, too. If people think prices of cars, appliances or homes will be higher next month or next year, they may buy now instead of waiting. Higher inflation may also allow the Federal Reserve to lower effective interest rates. If interest rates stay below inflation — though that’s hardly assured — the resulting cheaper credit should spur borrowing.

All this explains why higher inflation appeals to economists across ideological lines. While Rogoff is slightly right of center, liberal economist and columnist Paul Krugman also favors it. The trouble is this: Inflation is hard to manipulate in precise and predictable doses. Once people become convinced that government will tolerate or encourage it, they adapt in unforeseen ways. We can’t know what would happen now, but we do know what happened in the 1960s and 1970s.

One adaptation was that companies and workers raised wages and prices much faster than expected. Higher interest rates followed. Rates on 10-year Treasury bonds went from 4 percent in 1962 to 8 percent in 1978. The stock market stagnated for nearly two decades. Consumers reacted to greater uncertainty by increasing their savings rates from 8 percent of disposable income in 1962 to 10 percent by 1971. That’s exactly the opposite of today’s goal — more, not less, consumer spending.

There might be other unpleasant surprises. If retail prices rose faster than wages — a good possibility with unemployment at 9.1 percent — higher inflation could act as a drag on the economy by reducing workers’ “real” purchasing power. If investors decided that the Fed had gone soft on inflation, there might be a panicky flight away from the dollar on financial and foreign exchange markets.

Moreover, the power of higher inflation to erode the real valu eof U.S. government debt is limited, because much of that debt is short-term. About 30 percent matures in less than a year; another 25 percent or so matures in less than three years. All this debt will be refinanced. With higher inflation, it would probably be refinanced at higher interest rates that investors would demand as protection against rising prices.

Inflation is not the answer. Remember: The economy’s basic problem is poor confidence spawned by pervasive uncertainties. The Fed shouldn’t make the problem worse by embracing policies that, whatever their theoretical attractions, will create more uncertainties in the real world.

via Inflation is not the answer – The Washington Post.

This is what Christian presidential candidate William Jennings Bryan called for in the 19th century with his famous “Cross of Gold” speech, since inflation would make it easier for farmers to pay their debts over and against the banking interests.  Do you think higher wages and higher prices for everything would be a good way to get the economy moving again?

About Gene Veith

Professor of Literature at Patrick Henry College, the Director of the Cranach Institute at Concordia Theological Seminary, a columnist for World Magazine and TableTalk, and the author of 18 books on different facets of Christianity & Culture.

  • SKPeterson

    Abolutely ruinous, and not to the banks or holders of debt. Who will get these inflated dollars first? The banks. Who will get higher prices first, second and third, and then maybe a small wage increase? The poor. The old saw will be trotted out that the indebted poor will be able to pay off their debts with dollars that are less valuable, however how they are supposed to do this when their wages will not be increasing as fast as the prices of basic commodities, food, and fuel is often ignored. Moreover, this pulls many people who are getting by, but just, into the swirling vortex of economic instability of increasing prices and stagnant wages.

    Finally, Samuelson never explains how, under increasing price uncertainty and rising non-labor input costs, that they are supposed to increase hiring in the marketplace. This prescription will lead to that wonderful combination of increasing inflation and high unemployment known as “stagflation.” The arrogance that the Fed or other policymakers will even know when or how to shut off this inflationary increase without jacking interest rates into the lower stratosphere is also on display. This constant “trust us, we’ll get it right this time by spending even more money and making what money you do have worth less (a lot less) will fix it” from the same (insert favorite pejorative here)’s who advocated the policies that got us into this mess in the first place is doubly rich if it wasn’t so damnably frustrating and frightening.

    The economic and social dangers of this policy are far higher than any of the supposed benefits. The problem with the debt overhang is that we still have not devaluated many assets. This is not the same as deflation, but resetting prices to something approaching normal. Our government policies and programs have disrupted this process and our economy will not fully recover until it is complete.

  • SKPeterson

    Abolutely ruinous, and not to the banks or holders of debt. Who will get these inflated dollars first? The banks. Who will get higher prices first, second and third, and then maybe a small wage increase? The poor. The old saw will be trotted out that the indebted poor will be able to pay off their debts with dollars that are less valuable, however how they are supposed to do this when their wages will not be increasing as fast as the prices of basic commodities, food, and fuel is often ignored. Moreover, this pulls many people who are getting by, but just, into the swirling vortex of economic instability of increasing prices and stagnant wages.

    Finally, Samuelson never explains how, under increasing price uncertainty and rising non-labor input costs, that they are supposed to increase hiring in the marketplace. This prescription will lead to that wonderful combination of increasing inflation and high unemployment known as “stagflation.” The arrogance that the Fed or other policymakers will even know when or how to shut off this inflationary increase without jacking interest rates into the lower stratosphere is also on display. This constant “trust us, we’ll get it right this time by spending even more money and making what money you do have worth less (a lot less) will fix it” from the same (insert favorite pejorative here)’s who advocated the policies that got us into this mess in the first place is doubly rich if it wasn’t so damnably frustrating and frightening.

    The economic and social dangers of this policy are far higher than any of the supposed benefits. The problem with the debt overhang is that we still have not devaluated many assets. This is not the same as deflation, but resetting prices to something approaching normal. Our government policies and programs have disrupted this process and our economy will not fully recover until it is complete.

  • http://www.allenthemelancholy.com/ Allen

    The other path is to do what they are doing now, driving a high real inflation rate but changing the formula so that they report a small rate. Most people are experiencing 4-6% already with high gas and food prices, but govt is calculating their basket of goods closer to 2%.

    That is also how they are ‘fixing’ social security by not issuing COLAs.

  • http://www.allenthemelancholy.com/ Allen

    The other path is to do what they are doing now, driving a high real inflation rate but changing the formula so that they report a small rate. Most people are experiencing 4-6% already with high gas and food prices, but govt is calculating their basket of goods closer to 2%.

    That is also how they are ‘fixing’ social security by not issuing COLAs.

  • John

    And this will solve our lack of spending self-control how, exactly?

  • John

    And this will solve our lack of spending self-control how, exactly?

  • JH

    what SK said.

  • JH

    what SK said.

  • Michael Z.

    Really? William Jennings Bryan?
    There will be many failed and wrongheaded economic policies represented by the people who populate heaven, that doesn’t mean that we need to take them seriously here on earth.

  • Michael Z.

    Really? William Jennings Bryan?
    There will be many failed and wrongheaded economic policies represented by the people who populate heaven, that doesn’t mean that we need to take them seriously here on earth.

  • Patrick Kyle

    Lets not forget that such a policy will ruin those on a fixed income and penalize those of us who are financially responsible. It will harm those who save by devaluing the money they have saved, and it will finance those who hold debt on the backs of everyone else.

  • Patrick Kyle

    Lets not forget that such a policy will ruin those on a fixed income and penalize those of us who are financially responsible. It will harm those who save by devaluing the money they have saved, and it will finance those who hold debt on the backs of everyone else.

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    Inflation is basically the same as giving everyone a pay cut, except that it is so much worse because it also devalues cash assets.

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    Inflation is basically the same as giving everyone a pay cut, except that it is so much worse because it also devalues cash assets.

  • Steve Billingsley

    What strikes me about this is the constant inclination to tinker. One thing that the Fed or the federal government hasn’t done throughout the economic downturn is back off. At the end of the day, I think that this is more about hubris than about any real solutions that they have to offer.

  • Steve Billingsley

    What strikes me about this is the constant inclination to tinker. One thing that the Fed or the federal government hasn’t done throughout the economic downturn is back off. At the end of the day, I think that this is more about hubris than about any real solutions that they have to offer.

  • Cincinnatus

    Yup, screw the creditors to save the debtors.

  • Cincinnatus

    Yup, screw the creditors to save the debtors.

  • http://acroamaticus.blogspot.com Pr Mark Henderson

    I’m not an economist (obviously), but I can tell you the average Australian factory worker realizes that in the real world higher wages need to flow from higher productivity, otherwise you get ever higher inflation which reduces business profits and fixed incomes, increases the cost of borrowing and makes your economy less internationally competitive. And the US needs to be internationally competitive to pay off that international debt. Yet some American economists don’t get this?

  • http://acroamaticus.blogspot.com Pr Mark Henderson

    I’m not an economist (obviously), but I can tell you the average Australian factory worker realizes that in the real world higher wages need to flow from higher productivity, otherwise you get ever higher inflation which reduces business profits and fixed incomes, increases the cost of borrowing and makes your economy less internationally competitive. And the US needs to be internationally competitive to pay off that international debt. Yet some American economists don’t get this?

  • Jordan

    This doesn’t only take money from the creditors, but from the savers. The worlds assests are backed by US Dollars right now, as the reserve currency, and to intentionally inflate the dollars would put many lives at risk in countries that can’t as easily absorb the inflation in food and energy.

  • Jordan

    This doesn’t only take money from the creditors, but from the savers. The worlds assests are backed by US Dollars right now, as the reserve currency, and to intentionally inflate the dollars would put many lives at risk in countries that can’t as easily absorb the inflation in food and energy.

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