In an article published yesterday, the New York Times set forth the position that America needs to increase inflation in order to help get the economy moving again. All I can say is this: "Are they kidding?????"
The basic argument of the Times is that increase inflation will let companies raise prices and increase profits as a result. It will also encourage people to spend more since cash held for long will be reduced in value. Also, inflation helps people who have borrowed money since the debt is paid back with dollars that are not as valuable as those that were borrowed. The Times also talks about how falling prices or "deflation" is damaging to an economy.
So let's look at the answer to these points. Let's start with the issue of deflation. America is not suffering from deflation. We have not seen a year during which the Consumer Price Index, the usual measure of inflation, fell for at least 50 years. I think the figure is actually closer to 80 years since that happened, but I did not check back that far. There is no point talking about the evils of deflation when we don't have deflation here.
Second, the idea that people can repay loans easier if there is inflation is silly. The truth is that when money is lent, the interest rate charged increases enough so that expected inflation is covered. In other words, a loan made for 3% when there is no inflation would be made for 5% when inflation is at 2%. The bank lending the funds does not want to get back less valuable dollars, so it increases what it charges to cover expected inflation. In other words, an increase in inflation would drive interest rates higher and would therefore reduce borrowing.
Third, increasing prices do not help companies increase profits unless their costs stay stable. If Walmart is able to increase selling prices it will make more money unless its costs of goods, labor, etc. go up just as much. Higher inflation does not increase profits. It makes some companies more profitable and others less profitable. The overall effect is not helpful.
Finally, the idea that inflation will lead to increased spending is most likely true. The problem is that spending is most likely to be on consumption rather than investment. Inflation increases uncertainty and that makes investments less appetizing. Reducing investment is a much bigger blow to the economy than the boon that comes from increasing consumption.
The truth is that America is finally at a point where inflation is under control. It took decades to get there. Indeed, the one thing that we all should have learned from the last 40 years of dealing with inflation is that it is very difficult to control inflation once it has entered into the economy. In other words, when the Times talks of the need for more inflation, it is really advocating lighting the fuse for an explosion that no one will be able to control. Inflation is one of the few areas where the economy is in a good position. The thought that the Federal Reserve would actively take steps to foment an increase in inflation is crazy. It is the product of minds that actually believe that the federal government can control the economy. The truth is that the government can encourage the economy or it can hinder the economy by its policies. True control, however, is impossible.
The basic argument of the Times is that increase inflation will let companies raise prices and increase profits as a result. It will also encourage people to spend more since cash held for long will be reduced in value. Also, inflation helps people who have borrowed money since the debt is paid back with dollars that are not as valuable as those that were borrowed. The Times also talks about how falling prices or "deflation" is damaging to an economy.
So let's look at the answer to these points. Let's start with the issue of deflation. America is not suffering from deflation. We have not seen a year during which the Consumer Price Index, the usual measure of inflation, fell for at least 50 years. I think the figure is actually closer to 80 years since that happened, but I did not check back that far. There is no point talking about the evils of deflation when we don't have deflation here.
Second, the idea that people can repay loans easier if there is inflation is silly. The truth is that when money is lent, the interest rate charged increases enough so that expected inflation is covered. In other words, a loan made for 3% when there is no inflation would be made for 5% when inflation is at 2%. The bank lending the funds does not want to get back less valuable dollars, so it increases what it charges to cover expected inflation. In other words, an increase in inflation would drive interest rates higher and would therefore reduce borrowing.
Third, increasing prices do not help companies increase profits unless their costs stay stable. If Walmart is able to increase selling prices it will make more money unless its costs of goods, labor, etc. go up just as much. Higher inflation does not increase profits. It makes some companies more profitable and others less profitable. The overall effect is not helpful.
Finally, the idea that inflation will lead to increased spending is most likely true. The problem is that spending is most likely to be on consumption rather than investment. Inflation increases uncertainty and that makes investments less appetizing. Reducing investment is a much bigger blow to the economy than the boon that comes from increasing consumption.
The truth is that America is finally at a point where inflation is under control. It took decades to get there. Indeed, the one thing that we all should have learned from the last 40 years of dealing with inflation is that it is very difficult to control inflation once it has entered into the economy. In other words, when the Times talks of the need for more inflation, it is really advocating lighting the fuse for an explosion that no one will be able to control. Inflation is one of the few areas where the economy is in a good position. The thought that the Federal Reserve would actively take steps to foment an increase in inflation is crazy. It is the product of minds that actually believe that the federal government can control the economy. The truth is that the government can encourage the economy or it can hinder the economy by its policies. True control, however, is impossible.
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