Inflation? No, thank you.
We just endured and survived a major political crisis over the possibility that the U.S. government might default on its debts. Most people -- other than a few high-stakes poker players on the right wing of the Republican Party -- agreed that this would be a terrible thing. But now, a growing number of voices, mainly on the left wing of the Democratic Party but also in the Federal Reserve, are calling for what is in effect default in slow motion. It goes by the name of inflation.
Inflation decreases the value of debts, like the $14 trillion owed by the federal government to lenders such as the government of China (and a lot of ordinary American savers, too), and it increases the value of assets, like houses. Thus it helps all debtors, from the federal government to individual homeowners who can’t pay their mortgages. Inflation has been running at an average of 2.4 percent over the past decade. After a couple of years of, say, 6 percent inflation, that $14 trillion would be worth closer to $12 trillion in current dollars. A $400,000 mortgage would be worth about $350,000.
The U.S. government is going to be trying a tricky maneuver over the next couple of years. First, it wants to give the still-sickly economy another kick in the pants. That requires a larger federal deficit -- not as an unfortunate side effect, but because that’s how a stimulus works. Then, the government must perform a U-turn and concentrate on seriously reducing the deficit for our long-term economic health. A bit of inflation could help grease the wheels, by eroding the value of debt and debt-service payments.
Leading Economists Say
As it happens, a couple of years of 6 percent inflation is exactly what the leading economist advocating this approach -- Kenneth Rogoff at Harvard -- recommends. He is joined by Paul Krugman and by a growing number of economic journalists and commentators. Some of these people have been saying that inflation is no threat worth worrying about, because it has not appeared despite circumstances that ordinarily would have produced it. Now they say inflation is no threat because a little of it would actually be a good thing.
At Bloomberg View, we think that doing anything to encourage increased inflation is a very bad idea. People who advocate it are either too young or too old to remember our last adventure with inflation, in 1979 and 1980.
You can’t easily pencil in two years of 6 percent inflation and then go on your merry way. Inflation is self-feeding and takes on a life of its own. And it works only by surprise. If lenders all know that the government is going to induce or at least tolerate something like 6 percent inflation, they will demand something like 8 percent interest from borrowers. There goes the grease on the wheels. And it’s not just lenders: Labor negotiators will have their backs stiffened if they know that any dollar figure they negotiate will buy less and less. Manufacturers who know their inputs are going to be getting more expensive, in dollar terms, will raise their prices in anticipation, thus making inflation a self-fulfilling prophecy. Long-term planning becomes difficult to impossible.
It’s not just the economy. Inflation erodes the social fabric. Stable prices make for a stable currency, which is a cornerstone of a stable society. Inflation drives people into warring interest groups competing to stay ahead of the game. The ground beneath your feet becomes unsteady, as if in an earthquake. Like Alice in “Through the Looking-Glass,” you have to run faster and faster just to stay in the same place.
Back in the early 1980s, it took a deep recession to break inflation’s back, after it cost a Democratic president, Jimmy Carter, his job. It’s true that the inflation of 1979 peaked at an annual rate of 13.3 percent, more than double what Rogoff has in mind for our next round. But inflation is not a beast you can easily control once it is out of its cage.
It is true that inflation, on balance, hurts lenders and helps borrowers, and that, on average, borrowers tend to have lower incomes and to be suffering more from the effects of our current economic condition. But inflation is such a scourge that avoiding it leaves everyone better off in absolute terms.
We hope this lesson is not one that every generation has to learn for itself.
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