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October 27, 2013 5:41 PM Three cheers for inflation

By Kathleen Geier

Before I hang it up and hand the keys back to Ed, I wanted to be sure to say a few words about Binyamin Appelbaum’s very interesting New York Times article about inflation and macroeconomic policy. The piece suggests that, at long last, it is finally beginning to dawn on influential policymakers that inflation is too low, and that for our economy to fully recover, we need to see a significant hike in the inflation rate.

Currently, inflation is sinking to rock-bottom levels. In August, the yearly rate was 1.2 percent, which the Times notes is “just above the lowest pace on record.” It’s unclear exactly how high the ideal rate should be, but one economist quoted in the article is recommending a rate of 6 percent for a few years.

What are the reasons to believe a higher inflation rate would be a good for the economy? The Times story cites a number of them. They include:

1. Inflation is good for businesses’ bottom line — it tends to increase profits. This is why representatives from retailers like Costco and Walmart are quoted in the piece supporting an inflation hike.

2. Inflation is also good for the debtor class (i.e., you and me), because it shrinks the real size of our debt, which means more money in our pockets. More money in our pockets also means more money in circulation throughout the economy, which stimulates economic growth.

3. Finally, inflation is good for employment. As Nobel Prize winning economist George Akerlof (along with co-authors William T. Dickens and George L. Perry) argued in this paper, a firm that experiences an economic shock may want to cut wages in order to maintain profits. But given the notorious stickiness of wages, this is difficult. However, when prices are rising, firms have the option of reducing real wages quietly, by not allowing workers’ pay to keep pace with the rising cost of living. Thus, employment levels are maintained. Firms not experiencing a shock can do even better; in the inflation scenario, they are able to increase employment levels.

By contrast, in cases when there is no inflation, firms that are experiencing shocks have no choice but to lay off workers, if they wish to maintain profits. This seems to be the place where many firms are stuck now, given near-record low inflation and our sluggish economy.

If the Times article is right, it looks like many of our policy elites are finally giving up their inflation phobia (albeit not, apparently, all of them. Alan Greenspan, who is quoted in the Times piece, is still shrieking about the evils of inflation, though by now haven’t we established that the correct policy is always to do the exact of opposite of what he says?). The main problem, at this point, is not technical but political. Even if the Fed does the right thing, as they seem to want to do (have I mentioned that noted inflation dove Janet Yellen is Mrs. George Akerlof?), monetary policy alone won’t increase inflation. As Paul Krugman has pointed out, since we’re at zero lower bound, we’ll need expansionary fiscal policy to drive up inflation. But Congress being what it is right now, fiscal stimulus legislation is dead in the water.

The other major, and related, issue is point #2 above. Yes, inflation is good news for the debtor class, but it’s terrible news for the rentier class. And since the rentier class, otherwise known as the financial sector, nearly always gets its way politically in this country, I’m not optimistic on this front, at least not for the immediate future. We shall see.

Kathleen Geier is a writer and public policy researcher who lives in Chicago. She blogs at Inequality Matters. Find her on Twitter: @Kathy_Gee

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