Inflation as a strategy

According to the Washington Post, the chief of the Federal Reserve, Ben Bernanke, is working to increase inflation as a way to boost the economy:

In a January speech, Bernanke acknowledged the limits of liquidity and outlined a broader strategy in which the Fed would do everything in its power to increase credit. And last month, in an extraordinary interview on “60 Minutes,” Bernanke conveyed a powerful message with his words about the Fed “printing money” and with his body language, as he toured his home town in South Carolina and declared that he cares about Wall Street only because it affects Main Street — in part attempting to defuse criticism that the Fed lending was mainly benefiting bankers.

Clearly, the Fed chairman recognizes the severity of the problem and has decided to do whatever it takes to prevent anything like the Great Depression from happening again. Given where we are today, that means printing money, even if that runs the risk of creating a serious inflation problem.

Shortly after joining the Fed in 2002, Bernanke gave a speech describing how the Fed could prevent deflation, i.e., a general decline in prices. The key theme was that, in a pinch, the Fed could simply print more dollars — for example, by buying long-term bonds on the market — which reduces the value of each dollar in circulation and therefore raises the dollar price of goods and services. “Under a paper-money system,” Bernanke explained, “a determined government can always generate higher spending and hence positive inflation.” In a time of economic overconfidence, the discussion seemed largely academic. But it is now clear that Bernanke intends to follow through on it.

After the double-digit inflation of the 1970s and early 1980s, why would anyone want to create inflation? Households and companies alike are trying to “deleverage,” or pay down their debts. But deflation makes it harder to pay down debts, because debts are fixed in dollars and those dollars are becoming worth more and more. Moderate inflation in the neighborhood of 4 percent, by contrast, makes it easier for borrowers to manage their debt loads, and stimulates the economy.

Does that sound like a good plan? How will “positive inflation” work for employees whose salaries were frozen due to the earlier austerity measures?