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.
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?