Sunday, September 19, 2010

Will Higher Inflation Help the Economy?

In today's NY Times, Tyler Cowen presents a case for monetary expansion as a way to help the economy recover:

"The Federal Reserve, pondering what to do to stimulate the economy, has a number of tools at its disposal. But if it could just convince Americans that it was committed to monetary expansion and economic growth, it would help the economy pick up speed.

Yet that is easier said than done. Here’s the problem: The economy needs help, but monetary policy, which is the Fed’s responsibility, has not been very expansionary. This is true even though the Fed has increased the monetary base enormously since the onset of the financial crisis.

How can this be? Supplying more money did not actually result in enough additional spending. The debilitating financial shock of the last few years convinced many consumers and businesses that they needed to save more. So they are holding on to much of the new money.

Given this problem, there is a logical and seemingly simple move available to the Fed: just make people believe that it is seriously committed to increasing the rate of inflation.

As high unemployment continues, more and more people, including top economists, are asking the Fed to promise a credible commitment to a more expansionary monetary policy. This approach will work only if the Fed finds a way to be bold — and if we find a way to believe in it."
MP: The graph above shows that we may be getting some of the monetary expansion Tyler is advocating.  In the first week of September, M2 grew at an annual rate of 3.2%, the highest growth  in the money supply since mid-December of last year (data).  Given the low growth in real output (1.6% in QII 2010), we might have the ingredients necessary for some inflationary pressures, and according to Tyler an improvement in economic growth. 


At 9/19/2010 10:11 AM, Blogger morganovich said...

i realize that the "inflate the nation out of debt" idea appeals to those who seek growth uber ales, and while i have doubts it would rekindle and real growth, let's look at it another way for a moment:

is it fair?

cranking up inflation will help the debtors but at the expense of the savers. so, we would be punishing the virtuous to benefit the profligate. is that fair/just? is it even a good idea?

consider the moral hazard it creates. the debtors all get bailed out and the savers get screwed. that pretty much tells everyone which camp they want to be in for the next crisis. so we all spend like drunken sailors, go even more deeply into debt next time, and the next crisis is even worse.

that does not strike me as good policy.

those who sat out the boom now deserve bargains. those who ran up too much debt deserve the kicking they are going to get. if you break the linkage between risky actions and consequences, you'll get far too much risk and worse, you make the responsible pay for those who dug themselves into holes.

wealth is property. inflation destroys it. if we believe in property rights, how is a deliberate policy of high inflation not a violation of the property rights of savers?

if the government changed the zoning laws and put a fat renedering plant next to your house to "revitalize the town and provide jobs" you'd howl that your property was being damaged and devalued, even if it did provide a net benefit to the town. you would expect compensation.

why is devaluing your savings accounts and bond holdings by inflating for the common good any different?

At 9/19/2010 10:23 AM, Blogger PeakTrader said...

The Administration and Congress kept placing roadblocks to economic growth. So, of course, a V-shaped recovery couldn't be achieved. The Bureau of Consumer Financial Protection is another example.

Reducing uncertainty will help the economy. Bank credit remains low, because banks are less willing to lend and borrowers are less creditworthy.

At 9/19/2010 11:58 AM, Blogger Buddy R Pacifico said...

The guarantee of higher inflation seems a desparate choice in helping the economy.

Let's back away slowly from the notion of calling the Fed chairman Chief Inflation Guarantor. The Fed chairman should be talking about structural changes to the U.S. economy.

What is important is the veolicity of money that has been "printed". There is about a trillion dollars in cash in large U.S. corporations. A lot of it is in foreign affiliates of these corps. How can this money start moving to grow the U.S. economy?

I. Lower the U.S. corporate income tax considerably to repratraite the dollars to the U.S.

II. Replace some of the lost revenue with a Value Added Tax on goods and services.

The U.S. thinks of itself has a major player in world trade -- true. The problem is that the U.S. has major structural tax issues that don't align with the nations of the world in world trade and put the U.S. economy at peril for future growth.

The unwinding of debt leverage accounts for a lot of lost velocity but the key is to unlock the corporate vaults. Business needs to have a clear and compelling reason to move cash into U.S. business activities.

The result may or may not be higher inflation but surely more real economic growth.

At 9/19/2010 1:26 PM, Blogger PeakTrader said...

Buddy R Pacifico, U.S. income and spending on private goods are higher than its trading partners. So, there are trade imbalances.

I'd like to see the U.S. spend more on private goods, even if it means trillion dollar a year trade deficits.

Money shifted from taxes and profits into wages may raise U.S. living standards at a faster rate.

The U.S. needs to at least get back to 6% nominal growth (or 4% real growth) and 6% trade deficits, or 10% annual improvements in living standards.

At 9/19/2010 1:39 PM, Blogger Jason said...

It seems to me higher inflation policy, if pursued, would have to be a part of a larger, complete set of solutions. For instance, if higher inflation is necessary to reduce debt service as a percentage of GDP, then we need additional solutions so we are not borrowing crazy amounts to cover massive structural deficits we have (and are expected to have for the forseeable future).

The real question is do Americans have the courage to choose the difficult path out? I say unlikely. This is discouraging since the last time America traded its future, on this scale, for the status quo was lead up to the civil war. And today we do not have the expansion into the west to provide the revenues to fund reconstruction.

At 9/19/2010 1:53 PM, Anonymous Anonymous said...

Interesting post. Regardsless of the suggestions, there is no easy way out. I like the question proposed by Jason, "The real question is do Americans have the courage to choose the difficult path out?" Typically, the answer is no. I believe most Americans want change, as long it doesn't effect them.

At 9/19/2010 2:12 PM, Blogger Benjamin Cole said...

This is one of Dr. Perry's best posts ever.
We need monetary expansionism, and quantitative easing galore.

Milton Friedman visited Japan in the late 1990s, and advocated a ramp-up of the money supply there. As they were trapped at the "zero bound" (low interest rates) he advocated quantitative easing (that Japan's central bank print money and buy bonds). Japan did not listen.

Right now, we have two choices, Aggressive quantitative easing, and economic growth, or dithering nothingness, ala the Japan Wing of the Fed.

In Japan they have had 20 years of deflation, zero inflation, and an economy that has been outperformed by statist France. Their property and equity markets have fallen by 75 percent. Many people did not have children and now they have a shrinking labor force. They are becoming a backwater island, eclipsed by China.

This is the future that deflation will also bring to us.

PS Here is MF advocating QE for Japan.

BTW, must reading on monetary policy is Scott Sumner's Money Illusion blog.

At 9/19/2010 2:13 PM, Blogger Benjamin Cole said...


Is creating a deflation through tight money fair to people who borrowed to buy real estate?

At 9/19/2010 2:25 PM, Blogger PeakTrader said...

Some may recall Americans, and other foreigners, lent Greece "too much" money. U.S. external debt isn't high.

U.S. external debt is $13.5 trillion or 94% of GDP. However, Ireland's external debt is 1,004% of GDP, and many Western European countries have external debt between 100% and 500% of GDP (Luxembourg's external debt is 3,854% of GDP).

Real GDP growth and the prevention of deflation will help the economy more than higher inflation. However, a little inflation can boost "animal spirits."

At 9/19/2010 2:38 PM, Blogger Paul said...

"Right now, we have two choices, Aggressive quantitative easing, and economic growth, or dithering nothingness, ala the Japan Wing of the Fed."

Choice 3: Get your boyfriend's foot off the throat of the risk takers.

At 9/19/2010 2:46 PM, Blogger Jason said...

PeakTrader, our external debt problem is not the issue. The internal debt problem is a problem as is our unfunded liabilities. Internal debt is our governments answer when people like me say social security is bankrupt. The CBO says that the ssa's assets cover the shortfall. Well, those assets are T-bills. Insane.

At 9/19/2010 3:39 PM, Blogger PeakTrader said...

Jason, the U.S. will produce more than $160 trillion of output over the next 10 years, and household net wealth (assets minus liabilities) is currently $50 trillion.

When you can borrow at low rates and invest at high rates, buy goods at bargain prices, or save buying assets, Americans will borrow, invest, and spend.

Americans know they'll have to work longer, which will add to future economic growth.

Social Security and Medicare won't go bankrupt. The federal government will collect lots of tax revenues over the next 10 years. The question is how will those revenues be allocated?

At 9/19/2010 3:55 PM, Blogger Jason said...

PeakTrader, I don't share your optimism. Although, I agree that these programs can be viable with acknowledgment that the present rate or dispersement, and to whom dispersement occurs is unsustainable. The problem is what is dispersed far exceeds what is paid in, with unrealistic tax revenue growth targets. The same problem has happened with any large company with large pensions where growth stagnates. Nearly every time this has happened, the company has gone bankrupt. Steel, airlines, auto...

The problem is high fixed costs with no control over revenue - a receipe for disaster. Every level of the public sector is in this state presently.

We have challenges before us: Grow the Economy AND Cut Entitlements. We have to do both, not one or the other.

At 9/19/2010 4:18 PM, Blogger PeakTrader said...

Jason, I'm not trying to be optimistic. However, I agree, we need to promote economic growth, e.g. by cutting taxes and cutting spending or "reinventing" government to make it more efficient.

Hauser's Law states:

"In the United States, federal tax revenues since World War II have always been approximately equal to 19.5% of GDP, regardless of wide fluctuations in the marginal tax rate."

Also, the CBO states:

"By 2030, about 86 million people will be collecting Social Security benefits...CBO estimates that unless changes are made to Social Security, spending for the program will rise from 4.3 percent of GDP in fiscal year 2007 to 6.1 percent of GDP by 2030. With further increases in life spans, spending for Social Security will gradually rise thereafter."

At 9/19/2010 6:19 PM, Blogger morganovich said...


that's a meaningless straw man argument.

i'm not arguing for deflation and you know it. that's a totally disingenuous stance.

what we should be aiming for is very low inflation like we have now (if you believe the CPI).

at the risk of setting off this CPI measurement argument again, the current situation would have been called nothing like deflation during most of the post war period. it's only the changes in the 90s' that make it look that way.

MF's argument for QE is deeply flawed on an important way. sure, it might work, but it assumes that growth is the primary goal as opposed to fairness, moral hazard, and protection of property rights.

hell, if we going to do that, why not force all americans to spend 20% of their savings to drive growth. at least then they'd get something for it.

please note, i'm not advocating that policy, merely stating that it's preferable to inflating away savings and making a point of how ridiculous such inflate out of debt arguments are.

when you force savings liquidation, at least commerce gets done. 20% is a VERY light tax compared to what inflation did in the 70's. but it's very clear to people that such coercion is a significant breach of the american conception of rights (btw - the dutch do something like that, when they tax savings so this is not as far fetched as it sounds)

deliberately high inflation is the same theft of value but it gives savers nothing for it instead preferncing the profligate.

you are letting expedience get in the way of ethics benji.

sounds to me like you want QE (likely for yourself?) and don't care who it hurts or if it's fair or what bigger disasters it will lead to in the future.

that's pretty morally questionable.

for someone who opposed farm subsides so vehemently, you sure jump on board to support a borrower's subsidy if it benefits you.

At 9/19/2010 9:15 PM, Blogger juandos said...

Why inflate our way out this economic problem when dumping the entitlements would be easier and faster unless one is a politico?

At 9/19/2010 9:24 PM, Blogger Jason said...

Juandos, dumping entitlements would be great. Unfortunately, the "Anchor Class" is so large and dependent on the provider class, that dumping entitlements ina disorderly fashion would be chaotic. I mean we would be talking riots and martial law. We have to wind them down, probably over ten years or more. I mean it took 70 years to get here...

At 9/19/2010 9:35 PM, Blogger juandos said...

"Unfortunately, the "Anchor Class" is so large and dependent on the provider class, that dumping entitlements ina disorderly fashion would be chaotic. I mean we would be talking riots and martial law"...

Well jason there's no doubt in my mind regarding your assessment of what most likely will happen but then again unlike entitlements which aren't in the Constitution, there is the 2nd amendment to help us over that chaotic hump...

I wonder how many people wish they could get their FICA money back 'sans' any taxes being taken from it instead of going on SS instead?

We're just kidding ourselves if we think we can maintain this charade of pandering to the parasitic on the backs of fewer and fewer producers...

At 9/19/2010 10:36 PM, Blogger Benjamin Cole said...


I am not calling for runaway inflation. I am calling for single digit inflation.

Yes, I own property, and so do more than 60 percent of Americans. I am still above water on my property, but under the lulus who run the Fed, in 10 years maybe I will be underwater--like all property owners in Japan. Values just kept going down in Japan and will here too if we target zero inflation. Zero inflation is a dangerous utopian pipe dream.

BTW, I am totally on bpard for improving the economy structurally, such as wiping out rural subsidies, Fannie and Freddie, whack the military in half, trim Social Security and Medicare outlays by 10 percent, and eliminate HUD and the Department of Education.

But these structural improvement are not likely--in fact, they all grew worse when Bush Jr. was president and the R-Party controlled both houses.

So, we have to fall back on the Fed to stimulate growth.

At 9/20/2010 3:15 AM, Blogger niknaknoo said...

Inflation is a tax on people with savings. The only people who benefit are those who are first to receive the new money which is the government and banks. It will mean we all have less purchasing power. It will mean the trade deficit will increase because the things we import such as energy and consumer goods will become more expensive as the dollar depreciates. Debasing the currency is not the path to economic prosperity, never has been and never will be.

At 9/20/2010 6:27 AM, Blogger juandos said...

Mr. Delusional makes another silly and baseless comment sans anything credible to back it up: "But these structural improvement are not likely--in fact, they all grew worse when Bush Jr. was president and the R-Party controlled both houses"...


George W a progressive R.I.N.O. cast his share of expensive problems onto the taxpayer but obviously pseudo benny hasn't done his homework...

At 9/20/2010 7:08 AM, Blogger Paul said...

"in fact, they all grew worse when Bush Jr. was president and the R-Party controlled both houses."

Does anyone ever wonder if a coconut fell on Benji's head causing some bizarre brain damage, and now he's forever living in early 2007?

At 9/20/2010 7:21 AM, Blogger Jason said...

Juandos, I completely agree with you with regards to entitlements. But we have a big problem on our hands getting rid of them. And I'm not willing to just excersize my 2nd amendment rights and think that's a solution. There are millions of "Anchoroos" and they are all around us. Frankly, I don't think you would have enough ammo.

And practically speaking, this is still a democracy. So the minute we would put a governement in place to eliminate entitlements, there would be recall elections across the country.

We have to treat this problem like an addiction, like heroine. That means a treatment plan where we wean ourselves off the drug that is fixed cost entitlements and create a new America where accountability, savings and meritocracy matter again.

At 9/20/2010 8:50 AM, Blogger juandos said...

"But we have a big problem on our hands getting rid of them. And I'm not willing to just excersize my 2nd amendment rights and think that's a solution. There are millions of "Anchoroos" and they are all around us"...

Again jason you're absolutely right...

Actually I think I should've rephrased what should've been a 'tongue in cheek' comment better but now I can't really think of a way...

"And practically speaking, this is still a democracy. So the minute we would put a governement in place to eliminate entitlements, there would be recall elections across the country"...

Yeah, no doubt but correct me if I'm wrong since I don't have a recent SS proganda handout anymore but I thought there was something on each one they send out (in the fine print) about how Congress can stop the SS payments for any reason they please...

No, I don't expect this Congress or any Congress in the near future (short of something unbelievably catastrophic happening) to shut down the SS payments...

"We have to treat this problem like an addiction, like heroine"...

Personally I think that's a great analogy jason but addictive behavior is what it is and that's coming from someone who's addicted to his cigs...

The question is how do we wean a 150+ million off of the government dole?

First and foremost I don't think means testing should be applied since FICA was extorted equally from all...

I think maybe the answer lies in something like the following: Give States a Tool to Check Federal Power

Maybe the young people all ought to consider converting to the Amish faith to escape the tryanny of FICA extortion...:-)

At 9/20/2010 9:50 AM, Blogger morganovich said...


but you still want a borrower and homeowner subsidy through inflation despite not wanting anyone else to get one.

congratulations, you are as big a hypocrite as the farmers you excoriate.

you are either for subsidies or against them. being for them when you get them and against them when you have to pay is not an ethically tenable position.

At 9/20/2010 9:51 AM, Blogger morganovich said...


it was the fed trying to "stimulate growth" back in 2001 that got us into this mess.

rule one for getting out of a hole:

stop digging.

easy money does not cure the excesses of easy money.

At 9/20/2010 10:04 AM, Blogger PeakTrader said...

Morganovich, so you would've preferred a bigger mess than a smaller mess, e.g. a deeper recession in 2001, with a subpar recovery, like the one we have now.

Also, what's wrong with savers losing when they refuse to buy our goods?

At 9/20/2010 12:43 PM, Blogger Ron H. said...

"I think maybe the answer lies in something like the following: Give States a Tool to Check Federal Power"

The States already have that tool.

Remember that the States created the federal government, and conferred certain clearly enumerated and limited rights to it through the Constitution.

The Constitution grants NO rights to people or to the States, as they already have all those rights. It merely tasks a federal government with performing those functions the States agreed among themselves would be better handled by a central power, such as common defense. A common navy, for example, was preferred to 13 separate State navies.

At 9/20/2010 1:58 PM, Anonymous Anonymous said...

Cowen is an idiot, as are others who simply hope that inflation would help. First, all you're doing is imposing a tax on creditors and giving that money to their debtors, ie economic redistribution, with the hope that the debtors are stupider and more likely to spend it in the middle of a recession. Second, there's little evidence that in a modern economy that would work, as there are a lot of financial options these days. Those who gain from inflation are just as likely to dump it all into gold or other property, that won't change unemployment one whit. Frankly, it is hilarious to read someone supposedly "qualified" like Cowen espousing such stupid ideas. :)

At 9/20/2010 7:58 PM, Blogger morganovich said...


what we needed in 2001 was an actual recession so we could have an actual recovery.

instead, we got reckless fed and governmental lending policy (facilitated through the GSE's and CRA) which inflated a new bubble immediately out of the wreckage of the old and called it recovery.

worse, it took a relatively easy bubble to clean up (productive assets funded by equity) and turned it into the worst kind of bubble (non productive assets funded by debt).

that was not recovery, nor was it sustainable.

that was curing a hangover with cocaine.

is it any surprise that when the come down came, it was 5 times as bad?

"what's wrong with savers losing when they refuse to buy are goods?"

can you possibly be serious? what kind of fascist/communist philosophy is that? it's their money. it's private property. we and our finances do not serve a collective government.

are you seriously proposing that it's OK for the government to say "spend your money or we'll take it from you"?

whatever happened to freedom and personal choice?

At 9/20/2010 9:01 PM, Blogger juandos said...

"The States already have that tool"...

Yeah Ron H but that whole nullification bit is undergoing an experiment right now by about what? 20 or so states using different methods?

Here in Missouri we had a vote and Prop C passes overwhelmingly...

We know this is going to be tested in the courts...

We'll see...

At 9/20/2010 10:58 PM, Blogger Ron H. said...

juandos said...

"Here in Missouri we had a vote and Prop C passes overwhelmingly...

We know this is going to be tested in the courts...

We'll see...

And, what if the courts rule against Prop C? The whole issue is that the states are the ultimate arbiters of constitutionality. To consider the SCOTUS the ultimate authority is to allow the Federal government to judge the limits of its own power.

Fascinating ideas in that book I pointed out. I think you would like it a lot.

At 9/21/2010 3:04 AM, Blogger PeakTrader said...

Morganovich, so, we needed a deeper recession just so we could've had a stronger recovery. How "reckless" government was to prevent a worse period of idle resources.

There were too many resources in the Nasdaq bubble, including too much investment in depreciating assets. So, we had a quick and massive "creative-destruction" process mostly from 2000-02 (and in a mild recession).

We shifted resources into appreciating assets, i.e. building houses to raise actual output towards potential output. These were real assets fueled, in part, by the global saving glut.

And savers should lose when they fail to make appropriate adjustments with shifts in the goods market-money market-foreign exchange market.

At 9/21/2010 8:48 AM, Blogger morganovich said...


you have this all wrong.

the point of a recession is to wipe out excesses and shift assets to stronger holders.

that's what you need for a recovery.

this is econ 101 stuff.

however, if you cut rates too dramatically to spur growth, you inevitably get a debt bubble. too many assets are bought with borrowed money. if this really goes too far, you get an actual debt bubble (as we did).

americans repaired their balance sheet through massive debt accumulation and the asset speculation it fueled, not through actual economic rebuilding. such a trend has its foundations on sand. the last 10 years saw a quadrupling of consumer debt which moved to levels not seen in % terms since 1929.

the internet bubble left us with extremely useful infrastructure (like the railroad or electrification bubbles). the real state bibble left us with nothing new, just lingering debt. hopuyses are not productive assets.

money supply growth is not economic growth. the only reason 2003-7 looks like much growth at all is the CPI methodology changes. use the old one and real growth was pretty much nonexistent, hence the stagnation in most wages.

there is a big, big difference between savers losing by making bad choices and savers losing because the government is deliberately eroding their assets. your comment is either utterly disingenuous or displays some very limited economic and ethical understanding.

everyone cannot hide from inflation. you must know this. the very act of everyone trying to hide will drive HUGE inflation. that's how inflation becomes hyperinflation. you can't just shift the whole bond market to assets. that would be a wholesale slaughter and create horrible bubbles to boot.

claiming "you should have gotten a lifeboat" to the people on the titanic is a stupid argument. there are not nor can there be enough seats. and you want to set course for an iceberg then blame the passengers?

remember all the great things inflation created in the 70's? yeah, me either.

At 9/21/2010 4:55 PM, Blogger PeakTrader said...

Morganovich, yes, a deep depression once in a while is good for the American people, to get rid of the "excesses."

Right, living in a house is not a productive existance, like driving a car or wearing clothes.

Sure, there was no real growth. It was all changes in the CPI methodology.

This is all "econ 101 stuff" that's "either utterly disingenuous or displays some very limited economic and ethical understanding."

Those "horrible bubbles."

"You can't just shift the whole bond market to assets."

At 9/21/2010 8:19 PM, Anonymous Anonymous said...

Morganovich is right that the govt and Fed bringing down interest rates and spurring more home ownership through Fannie/Freddie was a bad idea, but Peak Trader is right to bring up the savings glut. No matter how much the govt pushed investment into housing, the fact remains that the worldwide savings glut pumped far more money into this dumb housing boom than any govt actors. The market is prone to periodic excesses when there's a bunch of capital to be invested and Wall Street is too stupid to figure out what's the best investment. Bankers needed something to seize on to sell as a good investment, so they seized on the nascent price increases in housing a decade ago and marketed the hell out of it. Well, such market stupidity is self-correcting, as the bubble inevitably bursts, dumb bankers are put out of business and credulous foreign savers and leveraged home owners lose out. The market helps teach people not to be stupid, it's just not instantaneous. ;) All the govt involvement, whether Fannie/Freddie or the Fed inflating, just makes things worse.


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