Sorry New York Times, Inflation Doesn't Lead to Growth
The New York Times, trying to smooth the way to Janet Yellen's confirmation as chair of the Board of Governors of the Federal Reserve, is extolling the virtues of inflation. Yellen, who favors a looser monetary policy that could lead to inflation, faces tough questions from the Senate Banking Committee in hearings next month.
In a front-page Sunday feature entitled "In Fed and Out, Many Now Think Inflation Helps," reporter Binyamin Appelbaum makes the dubious argument that inflation helps the economy.
Appelbaum quotes Havard economist Kenneth Rogoff, who reportedly said "a sustained burst of moderate inflation is not something to worry about. It should be embraced." Rogoff suggested that inflation levels of around 6 percent could help generate economic growth, according to the article.
This line of argument is fraught with problems. I will suggest just six.
It is difficult for the Fed to forecast a precise level of inflation and stick to it. As former Fed chair Alan Greenspan recounts in his book The Map and the Territory, forecasting is an imprecise art, not a science. In 2007, the Fed's models did not forecast the upcoming recession. Levels of inflation depend not only on interest rates set by the Fed, but by the willingness of banks to lend. The Fed could aim for a level of 6 percent inflation, and find itself with higher levels.
It is painful to get levels inflation out of the economy. America's experience of the 1970s and 1980s, shared with Western Europe, showed that eliminating inflation is no easy feat. In the early 1980s, Fed chair Paul Volcker took on the task of squeezing inflation out of the American economy. But it was not easy, and the economy got worse before it got better. The world does not need another bout of stagflation.
Inflation does not result in real economic growth. If inflation led to economic growth, countries would just have to open their monetary spigots and become economic winners. We do not observe this happening. As we saw in the 1970s, inflation does not lead to economic growth. Rather, we saw the reverse. Growth in the 1970s stalled. Countries that devalue their currencies see commodity prices rising in real terms, slowing their growth. Investment flees to sounder pastures.
Inflation plays tricks with legitimate contracts. Appelbaum suggests that inflation makes it easier for employers to lower wages. Wages look the same, but are reduced in real terms as inflation rises. An employer agrees to pay, say, $25,000 a year, but the next year, due to 6 percent inflation, the worker is paid $23,500 in the prior year's dollars.
Appelbaum even cites "an influential 1996 paper" by Yellen's husband, University of California (Berkeley) economics professor George Akerlof, without mentioning their relationship. The paper concludes that inflation allows profit margins to increase by holding down wages, allowing companies to hire more workers. Conversely, low inflation keeps employment down, Akerlof writes.
Of course, the worker will only stay in the job if he cannot find other employment opportunities. If the economy grows as Akerlof and Rogoff forecast, workers should have many other offers and will decamp to some better-paying job.
It is sad to see former Biden economic adviser Jared Bernstein's endorsement of whittling away wages through inflation in Appelbaum's article. Bernstein supports raising the minimum wages and requiring employers to offer health insurance to workers. Yet he does not mind reducing wages through inflation.
Does inflation raise or lower wages? As well as suggesting that inflation makes it easier for employers to use inflation to quietly lower wages, Appelbaum writes that "Historically, higher prices have led to higher wages, allowing borrowers to repay fixed debts like mortgage loans more easily." Which is it?
Yes, if wages keep up with inflation, then debt shrink in real terms. But lenders are not stupid: they raise their rates in anticipation of expected future inflation. They get from new borrowers what they are losing on the old loans. As with many government policies, the young lose. Mortgages in the 1980s were close to 18 percent.
Inflation redistributes, with damaging consequences. Inflation hurts retirees and other savers, and discourages people from accumulating assets for the future. It favors those with hard assets, such as real estate, and penalizes those who want to buy their first homes.
Inflation is no cure for our economic problems. A strong and stable currency works wonders. Those who advocate inflation in order to ease Yellen's path to confirmation have checked their principles at the door.