Some are pushing for inflation

Robert Samuelson:

It’s a sign of desperation that the latest cure being suggested for the ailing economy is higher inflation. In the 1970s and early 1980s, inflation (peaking at 13 percent in 1979 and 1980) was a national curse. Now, it’s being advanced as an antidote to high unemployment and meager economic growth. It’s bad advice for the Federal Reserve, which holds its annual research retreat at Jackson Hole, Wyo., this week. What seems plausible in the classroom would probably backfire in the real world.

The economy’s central problem today is lack of confidence — fear — reflecting enormous uncertainty. Business managers and consumers don’t know what to expect. Facing stubborn joblessness, falling home values and volatile stock prices, they have become reflexively defensive. They hoard and hold back. A deliberate policy of higher inflation risks compounding the uncertainty and poisoning psychology even more.

That’s what happened in the 1960s and 1970s. Economists argued that modest increases in inflation (say, to 4 percent or 5 percent) would reduce unemployment by allowing more expansionary budget and monetary policies. Slightly higher inflation wouldn’t bother most Americans, and lower unemployment would be a clear gain. But inflation wasn’t kept under control. Unemployment rose (it averaged 6.2 percent in the 1970s compared to 4.5 percent in the 1950s), and accelerating price increases spooked Americans.

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.

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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.

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This was Gov. Perry's concern when he made statements about not wanting the Fed to increase the money supply. Those actions have already increased the cost of many commodities. Going back to the bad old days of stagflation would be a major mistake.