Will Higher Inflation Help The Economy?
In today’s NY Times, Tyler Cowen presents a case for monetary expansion as a way to help the economy recover:
“The Federal Reserve, pondering what to do to stimulate the economy, has a number of tools at its disposal. But if it could just convince Americans that it was committed to monetary expansion and economic growth, it would help the economy pick up speed.
Yet that is easier said than done. Here’s the problem: The economy needs help, but monetary policy, which is the Fed’s responsibility, has not been very expansionary. This is true even though the Fed has increased the monetary base enormously since the onset of the financial crisis.
How can this be? Supplying more money did not actually result in enough additional spending. The debilitating financial shock of the last few years convinced many consumers and businesses that they needed to save more. So they are holding on to much of the new money.
Given this problem, there is a logical and seemingly simple move available to the Fed: just make people believe that it is seriously committed to increasing the rate of inflation.
As high unemployment continues, more and more people, including top economists, are asking the Fed to promise a credible commitment to a more expansionary monetary policy. This approach will work only if the Fed finds a way to be bold — and if we find a way to believe in it.”
MP: The graph above shows that we be getting some of the monetary expansion Tyler is advocating. In the first week of September, M2 grew at an annual rate of 3.2%, the highest growth in the money supply since mid-December of last year (data). Given the low growth in real output (1.6% in QII 2010), we might have the ingredients necessary for some inflationary pressures, and according to Tyler an improvement in economic growth.
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Inflation is never good. Do not believe the economists who say that. Inflation is hard to control and very easily escalate into hyper-inflation as it feeds on itself. When confidence in money is lost, velocity of money increases and the only way to stop it is by the Volcker method – high interest rate. When applied in this current situation will only lead to a depression. The best thing to do is to follow the Japanese and let the bubble slowly leak. Remember inflation is no good for almost everybody except the bankers while deflation is good for most people who are still employed and have income as their purchasing power is greater. Do not let a small loud group of people get us into trouble again. The big problem may be in the derivative market. Watch that one. One way for US to get out of trouble is to depreciate the currency, have inflation on the bad things like imported products while locally manufactured product become more competitive which means they will be cheaper. US have to work its way out of this by exporting as US had trade deficits for far too long. These deficits only benefit the bankers and the large corporations. The world needs a strong honest US.
Inflation is an easy sell to the US public, because they are mostly heavily indebted, and inflation erodes the real value of their debt – effectively pays their debts off for free. Who is going to argue with that? Who’s going to vote against it?
Devaluation is smarter for the economy but does not help the typical indebted man in the street so directly. It may improve his employment prospects, so he can pay back his debts, but that’s a harder sell for the politicians.