Mankiw & Rogoff: Why We Don't Need Economists
Given the almost monolithic failure on the part of economists to predict our present economic malaise, more than a few commentators have taken to asking why we rely on economists at all. Recent statements by economists Gregory Mankiw and Kenneth Rogoff lend credence to the discontent among the lay commentariat.
As Bloomberg reported on May 19th, Rogoff and Mankiw think heightened inflation is the cure for our sagging economy. In Rogoff’s case, he’s advocating “6 percent inflation for at least a couple of years”, while Mankiw says the Federal Reserve should pledge to create “significant” inflation. As the article noted, inflation “would make it easier for debt-strapped consumers and governments to meet their obligations”, plus it might encourage “Americans to spend now rather than later when prices go up.”
At first glance it’s easy to pick out the many problems with their analysis. While it’s certainly true that inflation drives cash-holding individuals to consume in the near-term, what neither economist has accounted for is that governments can at best reschedule consumption. If a weak dollar moves heavy consumption into the present, the economy will suffer from a dearth of consumption later on as debts come due.
It also has to be remembered that consumption is an overrated economic God. Broken down to the individual, we can see that if individuals consumed every dollar of every paycheck, they wouldn’t be well off; instead they would be living paycheck to paycheck. Since most big ticket items (think cars, houses, medical care) require more than one paycheck to finance, irrational consumption would put much of what we want out of reach altogether. Most important is the basic truth that any economy relies on entrepreneurial innovation in order to grow and attract more investment. If individuals are driven to consume with reckless abandon, entrepreneurs and businesses reliant on investment in order to grow will have a smaller pool of capital from which to draw from.
Inflation does help debtors as Mankiw and Rogoff suggest, but sadly, that’s only the seen. The unseen is the certain truth that lenders don’t sit idly by when central banks devalue the unit of account which they lend. Instead, they demand a higher rate of interest on money borrowed to account for the devaluation of the currency.
Rogoff thinks 6 percent inflation is the answer, but what he fails to acknowledge is that 6 percent inflation would double the admittedly worthless price level in twelve years. Put more simply, inflation always steals the benefits of devaluation because the cost of goods must rise to account for the weaker currency. Economists love to talk up devaluation, but their advocacy is naïve. The owners of my apartment could redefine what a square foot is tomorrow and my apartment would double in size, but I would still be cramped in the same apartment. Why economists don’t think this applies to money and the cost of goods will remain one of life’s enduring mysteries.
In the real world, however, devaluation does once again increase the cost of goods, so while Americans might be more eager to move up their spending in the near-term, longer term the value of their paychecks would shrink in concert with higher prices across the board. To clarify this, think of prices at the pump this decade. As is always the case, they rose when the dollar weakened. For Rogoff and Mankiw to suggest that a resumption of $4/gallon gas would be good is something they should be forced to explain in greater detail.
Sadly, the true ravages of inflation don’t end there. Indeed, when investors consider committing capital to anything, assumptions about inflation play a big role. They must due to the simple truth that inflation erodes the value of investment returns. If it’s assumed that the money they’re committing will be reduced in value by governmental mischief, it’s a certainty that they’ll invest the capital in a place where it will be treated better.
Notably, the above calculation greatly impacts the wages of the very individuals that Mankiw and Rogoff suggest they want to help. Simplified, there are no wages without capital, and capital providing investors naturally hate inflation. If the advice of Rogoff and Mankiw is followed, not only will Americans face higher prices in the future, but they’ll suffer those prices amid an investor strike as capital goes elsewhere, or into hard assets like property, gold and art.
This explains why the weak dollar era of the ‘70s, not to mention this decade, coincided with a great deal of economic unhappiness among the electorate. Inflation is death by a thousand cuts. Alongside the rising prices that it by definition generates, individuals suffer wages that can’t keep up with devaluationist policies thanks to investors fleeing to where currency oversight is responsible.
In truth, the currency policy we need today is the exact opposite of that which Mankiw and Rogoff advocate. Economies don’t just deteriorate, instead they descend when capital is treated badly. Inflation is the ultimate destroyer of capital, so if recovery is what we want, policy must center on strengthening our already weak dollar first, followed by stabilization of that same dollar; preferably in terms of gold.
If Rogoff and Mankiw get their way, what many term the greatest economist crisis since the Great Depression will intensify. Worse, and maybe this is a good thing, the reputation of conventional economists will plummet even more than it already has.