The Specter of Inflation
Only a few short months ago the media was raising the alarm about the impending threat of deflation. Deflation is the phenomenon of things getting cheaper. While that may superficially sound great, it is actually quite devastating to the economy. This segment from NPR’s Planet Money outlines the potentially troubling effects. The crux is this: we get stuck in a downward cycle of fear, unable to buy or make significant investments.
In the past few months, however, the forecasts for inflation (or even hyperinflation) have been raised dramatically. According to some economists, the national debt, combined with monetary policy that has no where to go but up, all but guarantees run-away inflation.
Paul Kasriel is one such economist, and Clusterstock sums up his position: we should expect, at a minimum, 3-4% inflation over the next few years.
Paul Krugman thinks this is mostly nonsense, and that we won’t see any type of inflation until wages increase. Clusterstock sums up part of the debate:
1. Different theories of inflation. In April, Bloomberg quoted Larry Meyer:
The Fed is “running a laboratory experiment” on what drives inflation: the money supply or the output gap, says Laurence Meyer, a former Fed governor and now vice chairman of St. Louis-based Macroeconomic Advisers
“How it turns out will do a lot to influence the economic debate,” he says, adding that his money is on Bernanke.
Krugman has long taken the output gap side of this debate. E.g., last year he wrote: “Calvo argues that inflation risks stem mainly from excess liquidity. He’s in good company there, but I won’t join in that chorus. In general, I don’t trust hydraulic metaphors for monetary economics.“
2. Wages vs. prices. The Krugman camp views wages as the key determinant of long-term inflation: as long as the cost of labor is contained, prices of goods and services will also be contained. Others think wages are often a lagging indicator, and therefore pay more attention to goods and services prices themselves, particularly commodity prices.
3. Time frame. In some cases, differing views about inflation risks are more apparent than real. Those who seem to disagree are sometimes talking about different time frames. Economists, and the reporters who relay their views to the public, are often vague about this.
4. Politics. Meltzer is much more worried than Krugman that political pressure will prevent the Fed from raising rates and shrinking its balance sheet rapidly enough once the economy recovers. Rogoff has a different reading on inflation politics. He thinks the Fed will voluntarily allow higher inflation on the grounds that a period of 1970s-style inflation would be helpful in reducing the debt overhang, notwithstanding the longer-term cost to the Fed’s inflation-fighting credibility. Mankiw, from what I can tell, would like the Fed to follow this course, but it’s not clear if he thinks it will happen.
Krugman continues this morning with his attempt to debunk a common idea that the last expansionary government program, the Great Society, ended in stagflation, the dreaded combination of a stagnating economy and inflation. If this were the case, it would seem that history is about to repeat itself. Krugman contends it is not:
The appearance of stagflation was a win for conservative economics, but it was conservative monetary economics that was partly vindicated: Milton Friedman’s assertion that there is no long-run tradeoff between inflation and unemployment turned out to be correct, and is now part of the standard canon.
But where is the Great Society in all this? Nowhere. The claim that stagflation proved the badness of liberal ideas is pure propaganda, which not even conservative economists believe.
So how to hedge your bets on this one? It’s unclear. Oil has already nearly doubled from it’s low point and other commodities are rising quickly. Sometimes it seems like there is no where to hide.
