{"id":415,"date":"2012-07-15T22:27:40","date_gmt":"2012-07-15T22:27:40","guid":{"rendered":"http:\/\/www.rationalargumentator.com\/index\/?p=415"},"modified":"2014-02-09T05:23:13","modified_gmt":"2014-02-09T05:23:13","slug":"not-enough-inflation","status":"publish","type":"post","link":"https:\/\/www.rationalargumentator.com\/index\/blog\/2012\/07\/not-enough-inflation\/","title":{"rendered":"Not Enough Inflation? – Article by Tyler Watts"},"content":{"rendered":"
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\"The<\/div>\n<\/div>\n
Tyler Watts
\n<\/big><\/big><\/strong><\/span><\/div>\n
July 15, 2012<\/big><\/span><\/div>\n
Recommend this page<\/a>.<\/strong><\/div>\n
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Two wrongs may not make a right, but a second dose of poison might just cure the first dose. That\u2019s at least what Paul Krugman, America\u2019s most prominent left-wing economic pundit, is saying about an untapped remedy for our economic woes. In his April 5 New York Times<\/em> column, \u201cNot Enough Inflation<\/a>,\u201d Krugman repeated his claim that \u201ca bit more inflation would be a good thing, not a bad thing.\u201d<\/p>\n

If you\u2019re wondering how progressively higher prices for everyday goods could help any household get ahead economically, let alone contribute to overall economic recovery, you\u2019re in good company. As all econ-principles students know, inflation is caused by an increase in the supply of money relative to money demand. The increase in consumer goods prices\u2014that\u2019s how the layman defines and experiences inflation\u2014is really just a symptom of the reduced purchasing power of money caused by the increase in its quantity. The higher prices for all goods in turn mean lower real incomes for consumers\u2014which is all of us\u2014not to mention that inflation is also typically symptomatic of the boom-bust business cycle and can cause significant widespread economic damage. In its most severe forms, inflation can wipe out people\u2019s monetary wealth and bring commerce to a halt.<\/p>\n

But smart guys like Professor Krugman aren\u2019t mere monetary cranks. They know that high inflation is economically dangerous. What they\u2019re asking for is just a small, temporary dose of fresh money to inject some new life into the economy. There is a kernel of truth to this inflationary prescription. As the Scottish philosopher David Hume explained in his 1752 essay Of Money<\/em>, prices for different kinds of goods react differently to new money entering the economy. Generally speaking, commodities or consumer goods prices will rise faster than wages. So for a manufacturing entrepreneur, for instance, who employs many workers, inflation will cause output prices (revenue) to increase relative to wages (costs), bringing an increase in profits that will induce an increase in output. Therefore, in Hume\u2019s terms, an increase of money \u201cmust first quicken the diligence of every [entrepreneur], before it increase the price of labor.\u201d<\/p>\n

This \u201csticky wages\u201d effect is what economists like Hume, John Maynard Keynes, and Krugman have in mind when advocating inflationary stimulus. Krugman also notes that \u201cparts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years,\u201d and that \u201cmodest inflation . . . by eroding the real value of that debt . . . [would] help promote the private-sector recovery.\u201d So higher inflation not only increases the demand for labor, but can also help clean up companies\u2019 and individuals\u2019 balance sheets, giving them the ability to ramp up their hiring and spending. What\u2019s not to love about this miracle elixir?<\/p>\n

There are two big problems with inflationary stimulus. The first involves the process dynamics of the market economy. The inflationists tend to omit the rest of the story, which involves the long-run<\/em> effects of new money. New money will eventually<\/em> increase all prices\u2014even wages\u2014meaning the stimulus effect can only be temporary. For if entrepreneurs read the price increases not as mere inflation, but higher demand for their products (as the inflationists hope), they are liable to make investments to expand their production capacity. Once the inflation effect peters out, once rising wages eventually push profits back down, they find that extra production is no longer profitable. The expansion can\u2019t be sustained without more inflationary stimulus.<\/p>\n

In a rising inflation environment, moreover, people will eventually come to anticipate further price increases. Workers demand upward wage adjustments in advance, and entrepreneurs anticipate rising costs and thus scale back their expansion plans. Once people catch on to inflationary stimulus in this fashion, larger and larger money injections (that is, higher inflation rates) are needed to merely maintain output levels. At some point, the high, rising, and volatile inflation rate itself becomes a drag on the economy. Miscalculation of next year\u2019s, or even next month\u2019s, inflation rate could spell disaster for entrepreneur and worker alike. As inflation heats up, it can actually drag investment down, as people seek to shelter their wealth in \u201csterile\u201d assets like gold. Inflation, instead of a stimulus factor, becomes a source of economic confusion and frustration. Iconic images of people hauling wheelbarrow loads of money to buy a loaf of bread in post-World War I Germany remind us of the potential economic turmoil of unchecked inflation. This of course is not what Krugman has in mind, but we should not forget that the mightiest river begins as a trickle.<\/p>\n

The second big problem with inflation is a moral one. Along with causing economic confusion, inflation redistributes wealth. The key fact here, again, is that not all prices rise immediately when new money enters circulation. People who are first to receive the new money get to spend it before prices go up. Those last in line see prices go up before their own incomes do. Inflation also redistributes wealth from lenders to borrowers, as Krugman indicated, by reducing the real value of debt. But Krugman conveniently ignores the corresponding fact that, whenever a borrower\u2019s real debt burden is eased, a lender\u2019s asset value is eroded. Thus to use inflation as a partial bailout for borrowers is to harm lenders and investors. This is happening already\u2014even at \u201cmild\u201d inflation rates that are too low for Krugman\u2019s tastes, real returns on investments like bank CDs are driven into negative territory.<\/p>\n

Through these redistributions of purchasing power, inflation acts like a tax: a tax on savers, on investors, on those at the very end of the monetary policy food chain. Ironically for Progressives like Krugman, this inflation tax arguably hits the poor and uneducated hardest. Educated, economically sophisticated people know the warning signs of inflation and know how to shelter their assets\u2014as attested by the flurry of gold bullion dealers\u2019 ads on cable news and AM radio. The poor are much more likely to be wage earners whose incomes tend to lag inflation, or pensioners who, even with annual cost-of-living adjustments, can still see consistent reductions in their purchasing power.<\/p>\n

Nonetheless, Krugman and the inflation party don\u2019t understand the free-market camp\u2019s arguments against inflation. He accuses us of \u201cobsessing\u201d over inflation, while he thinks the Fed should focus on curing unemployment. Even conceding that inflation can provide a temporary, halting employment stimulus, the objection remains strong. It comes down to the fact that inflation is a big lie\u2014or, should we say, a million little lies, because inflation distorts all prices and thereby hinders their crucial function of giving entrepreneurs and workers the correct information and incentives on which to make the best economic decisions. Inflation\u2019s promises of faster growth and greater wealth are illusory. Like alcohol or drug abuse, every high begets a crash that demands larger and larger doses to maintain the effect. Inflation is a dangerous medicine that stands to do the patient more harm than good.<\/p>\n

Tyler Watts<\/a> is an assistant professor of economics at Ball State University and the winner of the 2012 Beth A. Hoffman Memorial Prize for Economic Writing.<\/em><\/strong><\/p>\n

This article was published by The Foundation for Economic Education<\/a> and may be freely distributed, subject to a Creative Commons Attribution United States License<\/a>, which requires that credit be given to the author.<\/strong><\/p>\n<\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

Tyler Watts July 15, 2012 Recommend this page. ****************************** Two wrongs may not make a right, but a second dose of poison might just cure the first dose. That\u2019s at least what Paul Krugman, America\u2019s most prominent left-wing economic pundit, is saying about an untapped remedy for our economic woes. In his April 5 New York Times column, \u201cNot Enough Inflation,\u201d Krugman repeated his claim that \u201ca bit more inflation would be a good thing, not a bad thing.\u201d If…<\/p>\n

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