WI: Inflation Is Not Demonized -- An Economic PoD

For economists:

For a generation or maybe more central bankers of North American and European nations especially but also generally have seen it their prime duty to fight inflation and they are proud to keep it down below 2% and have no problem with keeping it at 1% or even below.

Inflation of course, is based on reduced purchasing power of money (that is increased prices) largely driven by circulation. Pump more liquid money into the economy, and the value of money goes down and prices go up since it now takes higher prices to get the same profit.

We're familiar with the issues of run-away hyper-inflation (Argentina in the past, Zimbabwe now). However, there is a school of economists that believe that central bankers are at this point, doing more harm than good in terms of fighting inflation. They can point to Japan where the desire to control inflation has continued to mire the Japanese economy in minimal growth despite usage of other tools (among other things). Another result of a determination to keep inflation very low in a recession is increased unemployment. Increased inflation can also help the average person since their debts are reduced (in real terms) and they tend to get raises.

A counterpoint is China. In the current recession China ignored worries about inflation and poured stimulus into its economy in a method similar to what is known as "qualitative-easing." Now that inflation is starting to take root in the Chinese economy, government policy makers are taking their "foot off the gas" so to speak and focusing a bit more than inflation. By contrast, the obsession with inflation fighting in the west has led to a much more restrained or retarded growth. It seems from published reports and interviews that central bankers are PROUD of low inflation and don't really care what the adverse effects are.

Basically my question for those with an economic bent: What would the world be like if a more balanced view of inflation v. unemployment had taken hold in the west?
 
Inflation wasn't demonized, or at least not in the sense that some small group of people disliking inflation caused monetary policy to change. What happened is people turned against an inflationary monetary and fiscal policy because the inflationists went overboard during the 1970's. You'll have to do something about that, and since the outcome of the 1970's was rooted in the system set up in the 1940's, you'll need to go pretty far back to avoid it.

However, in the economics profession, inflation has always had a somewhat bad rep -- the period of Keynesian dominance in from '36 to the 70's was an aberration, not the trend -- this will be a lot harder to change. I'm not even entirely sure it can be.

EDIT: And I won't even touch some of the other things you've said here. Inflation is not a panacea.
 
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EDIT: And I won't even touch some of the other things you've said here. Inflation is not a panacea.
Not calling it a panacea. But the point is that it's considered the priority no matter what the collateral damage and that simply is not the case. Right now there is minimal threat of inflation. Again, I'm talking about a more balanced approach.

Thanks for answering.
 
"More balanced view" is disputable.

In fact, the contention should not be more or less inflation but rather, inflation or deflation.

Increases in productivity should lead to price reductions , and thus a higher standard of living for everyone. That's deflation. Which is what happened in the Agrarian and Industrial revolutions. Greater yields, improved processes massively reduced the prices of first foodstuffs, and then manufactured goods .
 
"More balanced view" is disputable.

In fact, the contention should not be more or less inflation but rather, inflation or deflation.

Increases in productivity should lead to price reductions , and thus a higher standard of living for everyone. That's deflation. Which is what happened in the Agrarian and Industrial revolutions. Greater yields, improved processes massively reduced the prices of first foodstuffs, and then manufactured goods .
Deflation and depression go hand in hand. Deflation in the modern industrial world has always heralded a decline in real wages as well as significant unemployment.
 
Not calling it a panacea. But the point is that it's considered the priority no matter what the collateral damage and that simply is not the case. Right now there is minimal threat of inflation. Again, I'm talking about a more balanced approach.

Thanks for answering.
IIRC some Central Banks (like Canada's ?) have an inflation target of 2%, say. Something low, but positive.

Having LIVED through the 70's, I don't want to see that inflation return.
 
I live in Brazil,and in the 80's we had a 120% monthly inflation,yuo can not imagine how was it.And for those who thinks that your debts vanish that was just not true they were corrected by infltion plus interests,not say anything about the very much dreade monetary correction!
 
Deflation and depression go hand in hand. Deflation in the modern industrial world has always heralded a decline in real wages as well as significant unemployment.

Well, there's sector-specific pseudo-deflation--witness computers, for example, between 1940 and today. It's obvious that today's computers are enormously cheaper and superior in performance than those other computers, but that hasn't crushed the computer industry--much the contrary, in fact. I suppose you could call it secular deflation (= long-term fall in prices due to productivity increases, usually from improved technology and techniques) as opposed to shock deflation (= short-term fall in prices due to demand fall). IANAE, though, nor even an econophysicist, so take that with a shakerfull of salt.

And to all those saying, "Oh noes, the '70s!", what MNPundit is saying here seems to be strengthening the desire to implement fiscal stimulus in a recession without going overboard (like the '70s people apparently did). To take a page from this last recession, make it so that a decent stimulus package is considered a fairly standard response to a recession, and that central bankers might take the current economic state into greater account when deciding what the inflation target is.
 
During this crisis, most economists, including Bernanke, have felt inflation is less of a worry than getting lots of money in the economy to get the economy back on its feet by keynesian stimulus and other measures targeted to today's specific woes. That inflation shows up in Bernanke current worry list means he's alot less worried about the crisis.

Today, many economists like moderate positive inflation under 2-3%. Certainly, positive inflation is far better than even slightly negative inflation, which you'll see from time to time if you aim for zeroed-out inflation. Deflation makes depressions more likely. That said, we did see some modest deflation in this crisis without getting the depression, probably because the US and most other gummints were taking good countermeasures.

The 70s' woes were, I think, caused largely by Nixon, who set the 70's economy up to be perfect for his reelection in '72 at the cost of alot of the later decade. He set up a Keynesian simulus by pushing years of toilet paper and other routine spending forward to '72, costing later parts of the decade. He also set up wage and especially energy price controls, more stricly-good-for-'72 measures. Unfortunately, his successors took awhile to dismantle them, having been pursuaded by Nixon's arguments for them. Nothing like those is going on in the U.S. today.

Economists do have a balanced view of inflation vs employment - they believe they have to specifically balance on against the other in normal times, which these aren't. Are you wonering about whether economic virtue thinking were tuned more toward keeping down unemployment than inflation?
 
Obviously hyper inflation like Argentina is not a good thing, but sometimes inflation can be a good thing.

So yes, there's generally a trade off between employment and inflation. But this question was prompted when I read that Jean-Claude Trichet was quite happy with an inflation of 0.9% and Krugman's classic screed on Japan's bank. The issue is that Central Bankers seem to see fighting inflation as their one and only duty. So basically, what if keeping unemployment lower was valued on an equal footing with fighting inflation? I'm not saying go overboard with it, but simply to equalize the valuation.

I also think it wasn't just Nixon to blame for the 70s. Energy shocks can do that. What would happen to the US economy now for instance, if there was a sudden spike in energy prices? It can deliver a major blow to a weak economy. Then again, it's been shown time and again that economy does better under Dems generally.... but in the last year of the presidency of a Republican it spikes to above the Dem line. So I guess you never know. :D
 
Deflation and depression go hand in hand. Deflation in the modern industrial world has always heralded a decline in real wages as well as significant unemployment.
That's not always the case. In a ideal supply-side era (like the industrial revolution), lower prices and increased productivity (and thus more employment) come together. That's because it leads to a price reduction while overall GDP increases, creating a win-win situation for everyone.


@MNPundit:
I have a little theory on why the economy trends upward during Democratic eras and goes down during the Republican eras (its probably wrong, but you never know). Since the economy keeps fluctuating, periods of contraction and expansion alternate every few years. So, after a period of recession, it always recovers, but turns back into a recession a few month later.

Since people tend to elect Democrats during hard times, the economy starts out low, but naturally expands after a few month. After the economy recovers, people generally tend to elect Republicans due to their stance on lower taxes. So they come to power when the economy is good, and the economy naturally declines.

Since there's very little actual difference between the two parties, the whole trend you mentioned is probably due to natural economic fluctuations, and not due to policy differences.
 
So yes, there's generally a trade off between employment and inflation.

Yes. But fighting inflation using monetary policy instruments is rather easy. The tricky part, as you'd already mention, is fighting inflation without causing a recession. On the other side, promoting economic growth through monetary policy is not that easy - as we currently see. Therefore, you have some asymmetry in instrumental success: whereas central banks are rather successfull in fighting inflation, they are rather unsuccessfull in fighting unemployment - see for example the stagflation period.

The issue is that Central Bankers seem to see fighting inflation as their one and only duty.

Well, at least for the German Bundesbank and the European central bank, fighting inflation IS their foremost duty by charter. For the Fed, it's on par with promoting economic growth.

So basically, what if keeping unemployment lower was valued on an equal footing with fighting inflation?

Then the problem would be how to achive any success in promoting employment/economic growth WITHOUT causing massive inflation. In the stagflation period, monetary policy failed and in recent months, monetary policy failed to promote growth. Fighting inflation, however, is quite a success...
 
Not calling it a panacea. But the point is that it's considered the priority no matter what the collateral damage and that simply is not the case. Right now there is minimal threat of inflation. Again, I'm talking about a more balanced approach.

Thanks for answering.

In which case, that's what we've already got. The Fed is still operating under the dual mandate it's had for decades (low inflation, low unemployment), the profession in general is OK with relatively low levels of inflation consistent with a growing economy. At least amongst the right-ish blogosphere, right now, people are talking about an NGDP target, that is, having the Fed keep the nominal economy growing at a consistent (I've heard 5% a lot) rate year over year. Buried into this number is about 2% inflation.

"More balanced view" is disputable.

In fact, the contention should not be more or less inflation but rather, inflation or deflation.

Increases in productivity should lead to price reductions , and thus a higher standard of living for everyone. That's deflation. Which is what happened in the Agrarian and Industrial revolutions. Greater yields, improved processes massively reduced the prices of first foodstuffs, and then manufactured goods .

This is called a productivity norm and the small portion of the profession which spends it time looking at questions related to it believes that, from a policy point of view, a failure to follow one over the last twenty years is the 'active' cause of the housing bubble.

Deflation and depression go hand in hand. Deflation in the modern industrial world has always heralded a decline in real wages as well as significant unemployment.

Actually, 19th century America experienced significant, on-going deflation from the end of the Civil War to the founding of the Federal Reserve System and real wages actually greatly increased over the same period.

Sudden deflation shocks be the result of another, real shock and can help cause recessions and depressions, but a deflationary environment where the general deflationary trend is anticipated can be very survivable.
 
Deflation and depression go hand in hand. Deflation in the modern industrial world has always heralded a decline in real wages as well as significant unemployment.

Not so. for instance this series (taken from calculator at http://www.measuringworth.org/datasets/ukearncpi/result.php) show quite the reverse for the UK for nearly half a century.

Year..CPI..... Nom..Real
...................wages wages
1860 103.89 57.60 55.45
1861 105.11 58.31 55.48
1862 104.46 58.75 56.24
1863 100.29 58.64 58.47
1864 99.14 59.35 59.86
1865 100.87 61.09 60.56
1866 107.27 63.27 58.99
1867 112.95 63.87 56.54
1868 109.57 63.39 57.86
1869 102.38 62.80 61.34
1870 102.81 63.87 62.12
1871 105.69 65.90 62.36
1872 110.15 69.48 63.08
1873 111.01 73.11 65.86
1874 105.97 72.82 68.71
1875 104.39 72.37 69.33
1876 104.61 72.58 69.38
1877 104.53 72.58 69.43
1878 101.37 71.46 70.49
1879 96.84 70.19 72.48
1880 98.78 70.51 71.38
1881 97.56 71.16 72.94
1882 97.70 71.90 73.59
1883 97.70 72.40 74.10
1884 94.40 72.10 76.38
1885 91.10 71.50 78.49
1886 90.30 71.00 78.63
1887 88.50 71.40 80.68
1888 88.30 72.40 81.99
1889 89.00 73.90 83.03
1890 89.40 76.50 85.57
1891 90.10 77.50 86.02
1892 90.50 77.90 86.08
1893 88.70 77.70 87.60
1894 86.40 78.30 90.63
1895 85.20 78.40 92.02
1896 85.00 79.40 93.41
1897 86.70 80.80 93.19
1898 88.30 82.40 93.32
1899 87.40 83.80 95.88
1900 90.90 86.40 95.05



Prices trending down (deflation) , nominal wages rising (which certainly implies low or reducing unemployment - nominal wages seldom rise in periods of high unemployment ), real wages rising.

it is clear that an environment like this is far the best and fairest for everyone:

Those on fixed incomes benefit from reduced prices (though they may still suffer relative impoverishment because other groups benefit from the lower prices AND rising wages)
Wage and salary earners benefit both from price falls AND rising nominal wages
Investors benefit from a rise in real value of investments over time
Borrowers benefit because the repayment of their loans is made from a higher income base



Your statement is only valid when the deflation is a result of bubble bursting : when inflationary pressures, usually credit linked, have risen faster than gains in real productivity. Then the deflation is in fact simply a reconnection to reality, and the unemployment is not due to the deflation but rather to the reality effect removing jobs that depended on the bubble continuing.
 
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Ryan Advent (R.A.) has a new post up that touches on the issue and links apparently to a PDF paper with some date.

Conclusion Graph: Perhaps the important thing to take away from this discussion is that to central bankers, inflation is a bogeyman. But to good economists, inflation is merely a variable, an economic indicator over which governments have some control and which they can manipulate to good or ill effect. The right approach to inflation is to carefully weigh the costs and benefits of a higher target and determine if, as seems likely, it would be a good idea. It strikes me as a very good thing that prominent economists are raising these questions, and it would be a better thing still if central bankers would stop running in fear from the idea of higher inflation and start engaging the arguments on the table.

A healthy dose of inflation

  • Feb 15th 2010, 20:04 by R.A. | WASHINGTON
LAST week, IMF chief economist Olivier Blanchard released a staff position paper (PDF) with Giovanni Dell'Ariccia and Paulo Mauro examining the tenets of macroeconomic faith from before the crisis and suggesting ways that they might be in need of tweaking, given what we've learned from crisis and recession. Among the sacred cows being sized up for butchering is the importance of an inflation rate that is both stable and low—generally taken to mean 2% or below. Perhaps, Mr Blanchard says, this isn't such a good idea after all. Here's his reasoning:
When the crisis started in earnest in 2008, and aggregate demand collapsed, most central banks quickly decreased their policy rate to close to zero. Had they been able to, they would have decreased the rate further: estimates, based on a simple Taylor rule, suggest another 3 to 5 percent for the United States. But the zero nominal interest rate bound prevented them from doing so. One main implication was the need for more reliance on fiscal policy and for larger deficits than would have been the case absent the binding zero interest rate constraint.
It appears today that the world will likely avoid major deflation and thus avoid the deadly interaction of larger and larger deflation, higher and higher real interest rates, and a larger and larger output gap. But it is clear that the zero nominal interest rate bound has proven costly. Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.
Monetary policy is one of the few countercyclical tools that nearly every economist can get behind, and when inflation rates are kept persistently close to zero the effectiveness of monetary policy is limited. Paul Krugman notes that the above statement is interesting not just because Mr Blanchard is thinking along these lines, but because the IMF is releasing these thoughts as a staff policy note. But it's particularly interesting as Mr Blanchard is adding his voice to a growing chorus, including economists of highly divergent ideological stripes, supporting a move to higher inflation levels. Kenneth Rogoff, Greg Mankiw, Scott Sumner, Paul Krugman, Brad DeLong—all have indicated that higher inflation would be a boon to the struggling economy.
They have approached the subject from different directions, however. Mr Rogoff first made the case for a couple of years of inflation at 6% back in 2008, writing that a burst of inflation would make the burden of deleveraging and market clearing far less painful. American debt loads would constitute a persistent drag on growth, he noted, but could be reduced through an increase in the price level. Housing markets would clear more quickly if nominal prices were supported by a bout of inflation.

And while America's creditors could become nervous if the American government seemed determined to eliminate most of its sovereign debt burden via inflation, a commitment to a slightly higher rate of inflation could help take some of the pressure of debt reduction off a dysfunctional political system. It wouldn't be the first time America used inflation to ease an historically high debt level:
etween 1946 and 1955, the debt/GDP ratio was cut almost in half. The average maturity of the debt in 1946 was 9 years, and the average inflation rate over this period was 4.2%. Hence, inflation reduced the 1946 debt/GDP ratio by almost 40% within a decade.
Debt maturities are shorter now than they were immediately after the war, which would constrain the use of inflation to reduce the value of the debt. But so long as we're talking about a shift in the target rate from 2% to around 3% or 4%, the debt effect should be a salutary one.
Another case for inflation has been made with increasing vigour by Mr Krugman. He has noted that nominal wages adjust downward only with great difficulty, and so if inflation rates are consistently low, any needed downward adjustment in market wages will be slow and painful. If inflation is humming along at 4%, however, then real wages can adjust downward more easily, simply by not keeping up with the price level. A higher inflation rate is therefore consistent with greater labour market flexibility and lower unemployment.

A final push for greater inflation has come from those, like Scott Sumner and Greg Mankiw, who advocate the policy as a means to boost countercyclical monetary policy. Mr Sumner has pointed out that with nominal GDP growth running well below rates generally consistent with a healthy economy (5% per year, more or less) there is plenty of room for monetary authorities to more aggressively boost the economy. Additional inflation would also be stimulative thanks to its effect on the nation's current account, via the exchange rate. Mr Sumner cites Barry Eichengreen's research indicating that the massive currency depreciation associated with abandoning of the Gold Standard was the key to escaping the Great Depression—the earlier a country left gold, the faster it recovered. Monetary authorities could engineer a similar recovery today by committing to a 5% rate of nominal GDP growth, which implies inflation of 2% or more.

And Greg Mankiw has pointed out that a commitment to higher inflation would encourage households and businesses to spend money now, which would be stimulative, rather than hoard it. Several pundits have used this line of thinking to point out the strangeness of current Fed policy, which is to convince markets that it will soak up all of the excess liquidity in the banking system as soon as it appears that banks may be ready to use some of it. The Fed is obviously worried about runaway inflation, but given economic weakness, it seems odd to want to immediately neutralise any potential use of the funds it has provided to banks.

The thing is, Ben Bernanke is not unaware of the potential good that could come from inflation. In December he noted:
The public’s understanding of the Federal Reserve’s commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity. Indeed, the longer-run inflation expectations of households and businesses have remained very stable over recent years. The Federal Reserve has not followed the suggestion of some that it pursue a monetary policy strategy aimed at pushing up longer-run inflation expectations. In theory, such an approach could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward. The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve’s policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored.
The funny thing about this is that Mr Bernanke is concerned about the use of increased inflation expectations as a countercyclical tool, because he thinks it will reduce the effectiveness of monetary policy going forward. But what Mr Blanchard is arguing is that the opposite is true—monetary policy could potentially be more effective in a world where prices increase at 4% per year rather than 2%.

Things get really mind-blowing when one reads Mr Blanchard's explanation of why economists used to think that a higher inflation target wasn't necessary:
The danger of a low inflation rate was thought, however, to be small. The formal argument was that, to the extent that central banks could commit to higher nominal money growth and thus higher inflation in the future, they could increase future inflation expectations and thus decrease future anticipated real rates and stimulate activity today.
In other words, it was fine to have low inflation, because if monetary policy ever got wedged up against the zero bound, then the central bank could simply work to raise long-run inflation expectations. But that's just what Mr Bernanke is now refusing to do. This would seem to make the case for a higher target, in good times and bad, much stronger. If it seems likely that skittish central bankers will be reluctant to do what's necessary to raise inflation expectations when they're caught against the zero bound, then it makes sense to do what you can to keep them out of that situation.

I don't think anyone denies that there are potential costs to higher inflation. Stable inflation has been a hard-won success, and one that has paid significant dividends in emerging markets. Inflation is a distortionary tax, which poses certain costs on the economy. And obviously, runaway inflation can be extraordinarily devastating to economies and societies.

But central banks know how to fight inflation; they've done it plenty of times in the past. And the refusal to take better advantage of inflation as a countercyclical tool has led to a deeper recession than needed to have been, and the use of other countercyclical policies which may well have generated larger economic costs.

Perhaps the important thing to take away from this discussion is that to central bankers, inflation is a bogeyman. But to good economists, inflation is merely a variable, an economic indicator over which governments have some control and which they can manipulate to good or ill effect. The right approach to inflation is to carefully weigh the costs and benefits of a higher target and determine if, as seems likely, it would be a good idea. It strikes me as a very good thing that prominent economists are raising these questions, and it would be a better thing still if central bankers would stop running in fear from the idea of higher inflation and start engaging the arguments on the table.
I think the article is useful for pointing out the options are higher-inflation world in the last 30 years would have to deal with economic changes.
 
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