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Economic policy that rests on unexamined assertions will be as destructive today as it was in the first Great Depression
Keynes quipped in the General Theory that the world is ruled by the ideas of long dead economists. I was reminded of this comment when I heard a member of Germany's parliament scornfully dismiss the suggestion that the European Central Bank should target a somewhat higher rate of inflation. This suggestion had been put forward by Olivier Blanchard, one of the world's leading macroeconomists. Furthermore, he had proposed a higher inflation target in his role as the chief economist for the International Monetary Fund.
There is nothing wrong with disagreeing with an economist, no matter how prominent they are or where they work. But what was striking was the nature of the dismissal. The parliamentarian just asserted that: "Inflation never solved anything." That's a strong statement. Did he get that information from his parents? Or, as we used say growing up in Chicago: "Did your momma tell you that?" Blanchard and others arguing for a higher inflation target actually have very good reasons as to why higher inflation might be very helpful in solving the world economic crisis. First, a higher inflation rate will erode the real value of debt. This will benefit all debtors, households, businesses and countries.
In the case of households, tens of millions of homeowners in the United States and elsewhere have seen much or all of their equity disappear with the collapse of the housing bubble. A modest rate of inflation should begin to lift house prices, restoring equity to these families. It will also reduce the burden of their monthly mortgage payments if wages rise in step with inflation. This will not only be beneficial to these families; a lower debt burden will allow families to spend more, helping to drive the economy.
The same story applies to many businesses that are now facing crushing debt burdens. Furthermore the knowledge the prices of the items they sell will be rising 3-4% a year will make investment more attractive to businesses. Finally, a moderate rate of inflation can go far toward alleviating the debt burden faced by so many countries these days. After 10 years, a 3% rate of inflation will reduce the real value of a fixed debt by 26%; a 4% inflation rate will reduce it by 34%. The modest inflation of the 40s, 50s, and 60s, was a big factor in bringing down the huge US second world war debt to a manageable level.
Inflation can also be enormously helpful in allowing the eurozone countries with excessive labour costs (eg Greece, Portugal, and Spain) to get their costs more in line. If wages in more competitive countries keep pace or exceed average eurozone inflation, while wages in the troubled countries don't rise as rapidly, then they should be able to restore their competitiveness more quickly. These are the sorts of arguments that Blanchard and others have put forward for allowing a somewhat higher rate of inflation. But the German parliamentarian didn't care, because he somehow already knew that "inflation never solves anything".
Policy that rests on unexamined assertions (that emanate from the teachings of long-dead economists) will be every bit as destructive today as it was in the first Great Depression. In Europe, this drama seems to be playing out in the desire to really make Greece feel pain. Greece undoubtedly has to straighten out its fiscal mess. (Is there some reason that everyone is not pushing a tax amnesty programme as a way to reduce the Greek debt and show that it is serious about ending wholesale tax evasion?) However, it can't be expected to balance its budget in the middle of the worst downturn in 70 years.
The same applies to Portugal, Spain and other troubled European economies. Contractionary moves by these governments will worsen the downturn in these countries and in fact, make matters worse in the sound finance countries as well. Fewer imports in Spain and Greece mean fewer exports for Germany and France. Furthermore, enough downward pressure on these economies will likely require a debt restructuring at some point anyhow. The debt burden grows when economies shrink and that seems to be the plan coming from the economic centre of Europe. There might be some justice in the fact that the austerity plans designed by Germany will come back to bite them, but it would be much better to see the Germans design good economics policy. There was perhaps an excuse for bad policy in the 30s; after all Keynes didn't publish the General Theory until 1937. But, there is no excuse today "“ the ideas of Keynes have long been known and widely disseminated. It is a tragedy and an outrage that the people deciding economic policy are mindlessly repeating tired cliches rather than seriously trying to design policies that address the crisis in front of our faces.
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3 May 2010, 9:05PM
The trouble with this idealised view of inflation is you are detached from the reality of what actually happens.
Prices rise but wages rarely rise at the same rate as inflation so ordinary people suffer.
In addition, house prices are generally rising because of the lack of supply.
3 May 2010, 9:14PM
Inflation eats debt, but destroys savings.
And not too long ago young people did not expect to have a place of their own. They shared until marriage/partnership, sometimes with parents, more often in rather slummy houseshares.
But now the kids of the babyboomers want sole occupancy of an all mod-cons flat. That is where the housing shortage is coming from.
From nuclear family to nuclear person in one generation.
3 May 2010, 9:15PM
And a prize to the first person who blames the baby boomers
3 May 2010, 9:19PM
"but it would be much better to see the Germans design good economics policy"
What planet are you visiting? Germany is sound because it kept down inflation and remains competitive. Germany EXPORTS to China. Could it do that if it had adopted the head-in-the-sand type of Inflation - driven economy you are suggesting?
3 May 2010, 9:20PM
The transfer of billions to save the banks was a smash and grab by the ruling elite.For a generation, the people will be out of pocket while they as always will be laughing
3 May 2010, 9:23PM
Inflation sounds like robbery of savers to me.
The problem is that modern economists have failed to challenge dysfunctional modern tax systems and the principles that underly them.
The prospect of inflation just promotes a rush to property purchase as a shelter ie gives rise to another bubble.
Bad idea.
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