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How A Little Inflation Could Help A Lot

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http://www.nytimes.com/2009/08/02/business...ml?ref=business

BECAUSE fiscal stimulus has not yet been a striking success, perhaps it’s time to consider new monetary remedies for the economy.

That is the argument of Prof. Scott Sumner, an economist at Bentley College in Waltham, Mass., who is little known outside academic circles but whose views have been spreading, thanks to his blog, TheMoneyIllusion (blogsandwikis.bentley.edu/themoneyillusion/).

Professor Sumner proposes that the Federal Reserve make a firm commitment to raising expectations of price inflation to 2 to 3 percent annually.

In his view, policy makers in Washington are doing too much with fiscal policy — overspending and running excess deficits — and not doing enough on the monetary side.

While his views are controversial, they are based on some assumptions that are not. It is commonly agreed among economists that deflation brings layoffs and sluggish investment. Yet, energy price shocks aside, we have been seeing downward pressure on prices. Futures markets and Treasury Inflation-Protected Securities — more precisely, the spread between the yield on TIPS and traditional securities — suggest current expectations that inflation will remain well under 1 percent. Economists generally agree that this is not ideal, and Professor Sumner urges the Fed to try especially hard to overcome the deflationary pressures.

But how would the Fed accomplish this feat? This is where his recommendations get interesting.

The Fed has already taken some unconventional monetary measures to stimulate the economy, but they haven’t been entirely effective. Professor Sumner says the central bank needs to take a different approach: it should make a credible commitment to spurring and maintaining a higher level of inflation, promising to use newly created money to buy many kinds of financial assets if necessary. And it should even pay negative interest on bank reserves, as the Swedish central bank has started to do. In essence, negative interest rates are a penalty placed on banks that sit on their money instead of lending it.

Much to the chagrin of Professor Sumner, the Fed has been practicing the opposite policy recently, by paying positive interest on bank reserves — essentially, inducing banks to hoard money.

The Fed’s balance sheet need not swell to accomplish these aims. Once people believe that inflation is coming, they will be willing to spend more money.

In other words, if the Fed announces a sufficient willingness to undergo extreme measures to create price inflation, it may not actually have to do so. Professor Sumner’s views differ from the monetarism of Milton Friedman by emphasizing expectations rather than any particular measure of the money supply.

The Keynesian critique of this remedy is that printing more money won’t stimulate the economy because uncertainty has put us in a “liquidity trap,†which means that the new money will be hoarded rather than spent. Professor Sumner responds that inflating the currency is one step that just about every government or central bank can take. Even if success is not guaranteed, it seems that we ought to be trying harder.

Arguably, we can live with 2 or 3 percent inflation, especially if it stems the drop in employment. Consistently, Professor Sumner argues that the Fed should have been more aggressive with monetary policy in the summer of 2008, before the economy started its downward spiral. Somewhat tongue in cheek, he once wrote on his blog: “Like a broken clock the monetary cranks are right twice a century; 1933, and today.â€

It may all sound too simple to be true, but has the status quo been so good as to silence all doubts? Many advocates expected that the $775 billion allocation to fiscal stimulus would be followed rapidly by generous funding for health care and other reforms. But at the moment, the American public, rightly or wrongly, is blanching at higher government spending and higher taxes. In contrast, a Fed stance in favor of mild price inflation need not require higher taxes or larger budget deficits.

While these arguments have not won over the economics profession, neither have they been refuted. Economists like Paul Krugman have suggested that a public Fed policy favoring 2 or 3 percent price inflation isn’t politically realistic in today’s environment. Still, mild inflation might still be a better shot than hoping for a fiscal stimulus that is big enough, rapid enough and ambitious enough to work.

IF there is a flaw in Professor Sumner’s argument, it is that aggregate demand doesn’t always drive business recovery. Circa 2007, for reasons of their own making, various sectors of the economy were in a vulnerable position. These included real estate, the automobile industry and retail sales. Higher price inflation would not have solved their problems, which stemmed from basically flawed business models that depended on rampant credit. Still, a different Fed stance might have limited the secondary fallout from the financial crisis.

No we can't live with inflation at 2%-3% this will eventually run into the exponential growth problem, and you can't have continually expansion. God we have some prize idiots in academics posts.

There's more at the link, although then end of what I quoted is clearly highly relevant the problems we have no have nothing to do with price inflation but the fact that credit has imploded.

What is it about economists and the fact that they won't admit the natural state of a healthy economy is to expand and contract, they all seem to play to the politicians with statements perpetual growth is possible.

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http://www.nytimes.com/2009/08/02/business...ml?ref=business

No we can't live with inflation at 2%-3% this will eventually run into the exponential growth problem, and you can't have continually expansion. God we have some prize idiots in academics posts.

There's more at the link, although then end of what I quoted is clearly highly relevant the problems we have no have nothing to do with price inflation but the fact that credit has imploded.

What is it about economists and the fact that they won't admit the natural state of a healthy economy is to expand and contract, they all seem to play to the politicians with statements perpetual growth is possible.

State education system.

If you don't believe ********, you don't get your piece of paper.

No piece of paper, no academic work.

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