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Over the summer, a lot of the inflation debate has basically been economists of the Keyensian stripe reassuring their monetarist colleagues that the extraordinary measures needed to fight the recession, even when laid on top of the structural deficits created by the Bush administration, aren't going to lead to a huge increase in the inflation rate and all of the economic problems like that go along with it, with bonds becoming onerously expensive and purchasing power diminishing.But now that empirical evidence shows that inflation is not a problem, some people are questioning whether a policy that pursues a slightly higher inflation rate might be a smart idea. Matt cites an argument that a higher inflation rate will put the Fed in a better position to deal with a future crisis: Right now, the Fed has lowered the interest rate to zero in order to spur investment, but this will also have negative affects on recovery and limit options in the face of a future recession. More accessible is this paper by Chris Hayes at the New America Foundation, which argues that a "moderate period of sustained inflation" will help speed up on of the biggest challenges of recovery by unwinding the massive amounts of debt accumulated by the government, business and consumers:
Historical parallels for our current predicament are difficult to come by. But given that fiscal scolds, inflation fear-mongers, and other critics point to the levels of government of debt rising to WWII levels, it is worth looking at just how the United States recovered from that period of unprecedented debt. The answer, to simplify a bit, was growth and inflation, with the two likely reinforcing each other. From 1948 - 1980, the annual inflation rate was 4.1 percent while real GDP growth averaged 3.7% a year. By 1980, federal government debt held by the public had been cut by more than half, falling from 84 percent of GDP in 1948 to just over 26 percent.The inflation rate in the U.S. right now is less than one percent after a year of decline. Hayes' whole article is worth reading as a discussion of how the last 30 years of empirical data suggest we should cast off now-discredited ideas about inflation and unemployment to help clean up after this crisis. Moving forward, it will be interesting to see how inflation proponents will influence the broader debate over deficits and debt that mostly involves rhetorical concessions to the debt hawks.
-- Tim Fernholz
