Is a little inflation good for the economy?
by. Henry Meier
Sunday’s New York Times included the type of headline which borders on heretical to anyone who has been keeping an eye on monetary policy since the days of Paul Volcker: ”In FED and Out, Many Now Think a Little Inflation Helps.” Don’t underestimate how big a deal this assertion is or how much it could further politicize the nomination of Janet Yellen to be the next chair of the Federal Reserve Board.
Conventional wisdom has it that in the early 1980s Paul Volcker ruthlessly raised interest rates in order to tame inflation. His actions may have exacerbated an economic downturn, but they also laid the groundwork for more than two decades of solid economic gains. As a matter of fact, while the FED has a mandate to both keep inflation in check and maximize employment, almost every FED chairman has inflation fighting credentials at or near the top of his curriculum vitae. As explained in the article, this bias reflects the country’s past experience with inflation eating away at the standard of living while producing little countervailing economic gain.
As Keynesian economics became the predominate economic school after World War II, there was wide acceptance of the view that inflation was a necessary trade-off for a growing economy. More people with jobs meant more people with money; more spending meant more inflation. However, starting in the late 1960s, Milton Friedman began to argue that over the long-term intolerance of inflation in the name of maximum employment would simply lead to a stagnating economy where prices rise but spending power diminishes and fewer people can ultimately find work. His views were vindicated by ’70s stagflation laying the groundwork for Volcker’s actions.
But suddenly, inflation doves are coming out of the closet. I was a little surprised to see the number of people who are willing to talk boldly about the need for the FED to tolerate inflation and even encourage it. In a blog post yesterday evening expounding on his views, Jared Bernstein, who was formerly Vice President Biden’s top economic advisor, explained that higher inflation rates would have the effect of reducing debt burdens and enticing companies with inflated profit margins to borrow more money for expansions. You may be charging a member $350 each month now to repay a car loan, but if that same member suddenly sees an increase in salary, you won’t be able to make that member make higher monthly payments. In addition, a rise in inflation, he argues, might actually increase consumer confidence by increasing the wages of the American worker.
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