The Greek Crisis and Our Parents’ Economics
There is nothing wrong with disagreeing with an economist, no matter how prominent they are or where they work. But what was striking was the nature of the dismissal. The parliamentarian just asserted that: “inflation never solved anything.”
That’s a strong statement. Did he get that information from his parents? Or, as we used to say growing up in Chicago, “Did your momma tell you that?”
Blanchard and others arguing for a higher inflation target actually have very good reasons as to why higher inflation might be very helpful in solving the world economic crisis. First, a higher inflation rate will erode the real value of debt. This will benefit all debtors, households, businesses and countries.
In the case of households, tens of millions of homeowners in the United States and elsewhere have seen much or all of their equity disappear with the collapse of the housing bubble. A modest rate of inflation should begin to lift house prices, restoring equity to these families. It will also reduce the burden of their monthly mortgage payments if wages rise in step with inflation. This will not only be beneficial to these families; a lower debt burden will allow families to spend more, helping to drive the economy.
The same story applies to many businesses that are now facing crushing debt burdens. Furthermore the knowledge the prices of the items they sell will be rising 3-4 percent a year will make investment more attractive to businesses.
Finally, a moderate rate of inflation can go far toward alleviating the debt burden faced by so many countries these days. After 10 years, a 3.0 percent rate of inflation will reduce the real value of a fixed debt by 26 percent; a 4.0 percent inflation rate will reduce it by 34 percent. The modest inflation of the 40s, 50s and 60s was a big factor in bringing down the huge U.S. World War II debt to a manageable level.
Inflation can also be enormously helpful in allowing the euro zone countries with excessive labor costs (e.g. Greece, Portugal and Spain) to get their costs more in line. If wages in more competitive countries keep pace or exceed average euro zone inflation, while wages in the troubled countries don’t rise as rapidly, then they should be able to restore their competitiveness more quickly.
These are the sorts of arguments that Blanchard and others have put forward for allowing a somewhat higher rate of inflation. But the German parliamentarian didn’t care, because he somehow already knew that “inflation never solves anything.”
Policy that rests on unexamined assertions (that emanate from the teachings of long-dead economists) will be every bit as destructive today as it was in the first Great Depression. In Europe, this drama seems to be playing out in the desire to really make Greece feel pain. Greece undoubtedly has to straighten out its fiscal mess. (Is there some reason that everyone is not pushing a tax amnesty program as a way to reduce the Greek debt and show that it is serious about ending wholesale tax evasion?) However, it can’t be expected to balance its budget in the middle of the worst downturn in 70 years.
The same applies to Portugal, Spain and other troubled European economies. Contractionary moves by these governments will worsen the downturn in these countries and in fact, make matters worse in the sound finance countries as well. Fewer imports in Spain and Greece mean fewer exports for Germany and France. Furthermore, enough downward pressure on these economies will likely require a debt restructuring at some point anyhow. The debt burden grows when economies shrink and that seems to be the plan coming from the economic center of Europe.
There might be some justice in the fact that the austerity plans designed by Germany will come back to bite them, but it would be much better to see the Germans design good economic policy. There was perhaps an excuse for bad policy in the 30s; after all Keynes didn’t publish the General Theory until 1937. But, there is no excuse today – the ideas of Keynes have long been known and widely disseminated. It is a tragedy and an outrage that the people deciding economic policy are mindlessly repeating tired clichés rather than seriously trying to design policies that address the crisis in front of our faces.
There is one additional effect: Expecting (moderately) rising pricing will induce consumers to spend more out of their accumulated wealth (and rising income), they are also more prone to buy on credit – all of which provides some stimulus to the economy.
I can hardly believe I just read “A modest rate of inflation should begin to lift house prices, restoring equity to these families”. Asset price inflation is of no use to anyone except speculators and the banks (the banks collect the rent and the speculators take the capital gain). Assets are for use not a tool for investment. Property,i.e. land, speculation is of the very worst kind because land is a gift of nature and its value is determined by human activity and public investment and we can do nothing, not even live, without land.
Fortunately there is an easy fix for it – the collection of all land rent for public benefit.
It’s about time economists started to recognise the role of the land market in financial crises.
Carol:
I symnpathise with part of your position, but your arguments risk being counter-productive. First, mild CPI inflation (which expludes asset prices) tends to erode the value of mortgages which is good for ordinary householders (for whom a mortgage is a liability) and bad for banks (for whom it is an asset). Secondly, many progressive economists favour some form of land value tax, while not sharing the Georgist position that such a tax is dictated by ‘natural law’.
Unfortunately it’s impossible to have a sensible discussion on inflation here in Germany. Whenever somebody states the obvious fact that an inflation rate of 3, 4 or maybe 5 percent does not mean the end of the world, someone else says “remember the hyperinflation of 1923″. End of discussion. German policymakers do not want to hear about Philips curves or NAIRU’s or something like that. They already know everything there is to know: inflation is evil and must be prevented at all costs.
That is why we’ve had practically zero inflation coupled with mass unemployment for about 30 years now.
Oh and another thing about the German view on inflation. Henrik Müller, an highly influential journal ist who write for Spiegel (the leading German weekly) and Manager Magazin, recently published a book titled “Sprengsatz Inflation” in which he claims that inflation endangers the democratic system and that the German hyperinflation of 1923 was more or less directly responsible for Hitler’s rise to power. The book is selling well because it got a lot of promotion by Spiegel. It’s really quite hard to inform voters about actual economic relationships while they’re being bombarded with such nonsense.
I can see why Germany-bashing regarding inflation is timely, easy, and popular – and in some respects, not without reason, either. However, to claim that the German attitude is based only on the irrational fear that the 1923 Inflation may reoccur is clearly misleading. The first fact is that many Germans, if not most (and certainly most of a key segment of the population) have their assets in currency-based investments, and inflation is a net loss for them. As their life quality and future rest on a stable currency, and as they were always and unequivocally promised that, it’s hardly surprising that they mind. The second fact is that a vast majority of Germans do not feel a pan-European solidarity to the extent that they want to finance other countries, especially if they are seen to have brought on their economic problems themselves (by nepotism, corruption, and leisure orientation, as it is usually seen). Add to this that a positive overall effect of inflation on the German economy can be claimed but not proven within our ruling episteme (note that the original posting just said that the German MP was wrong, but not disproving him or her even with a case where inflation did help), and to be totally against inflation is entirely rational. This is not a case of an evil elite imposing wrong economics on a witless and hapless people, but of politicians representing the well-considered self-interest of their electorate (which, one may at least argue, is not exactly the opposite of democracy…). One may not like any of this, but the problem is then elsewhere.