Tuesday, August 09, 2011

Inflation: The Power of Ideas

I’m with Keynes in thinking that the power of ideas is usually underestimated. As Keynes also noted, this applies even to bad ideas.

Inflation is bad, so we have all been taught, and the confirmatory evidence is plentiful, especially for the great inflationary bugaboo, hyper-inflation. I was reading some comments on the WaPo, and ran across one hysteric who was bent out of shape because Obama was “producing inflation and devaluing the dollar.” Now neither accusation has any truth to it, but my reaction was “would that it were so.”

The thing is that the great threat to the economy today is not inflation, but deflation, and a little inflation would be good for the economy. Like most other medications, inflation, even in small doses, is not without adverse side effects – for some. Right now we have an economy which is producing far less than it can because a huge portion of our population is either unemployed or under employed. Too few goods are being produced because there are too few who can afford to buy them – or equivalently, too little money is chasing to many goods. Inflation is the opposite disease.

So how do you produce “a little inflation?” Not to put too fine a point on it, you print some money and give to people who will spend it – ideally getting some socially valuable goods in return. This gets people employed and can also buy schools, roads, scientific research, and other public goods.

So whom does inflation hurt? Indirectly, it hurts us all, since we all wind up paying more for the same goods. Those whose incomes are truly fixed are especially affected. Those really hurt the most though are bankers, and the rentier class generally. That’s because the money that they lent out at interest will be repaid with less valuable money. Conversely, it helps anybody who owes money, since they will be repaying those loans with less valuable money. For those who weep for Wall Street, this is a terrible crime. On the other hand, if you remember that these same bankers recently got bailed out of the swindle they worked on the rest of us with our tax money, your tears may be assuaged.

One way to think of it is that inflation is a tax on money – your money becomes less valuable with time. This is an encouragement for those with money to convert it into goods which can be enjoyed or to keep their value. That is an important aspect of its stimulative effect on the economy.
The real trouble with inflation is that it is an addictive drug – powerful and euphoric initially, but debilitating if allowed to continue. What we probably really need is 3-6 years of 4-5% inflation, followed by a return to a more normal 2 % inflation. That would ease certain debt burdens, get a lot of mortgages above water, and power up the economy.