U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff

[Puppycow]

U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff

May 19 (Bloomberg) -- What the U.S. economy may need is a dose of good old-fashioned inflation.

So say economists including Gregory Mankiw, former White House adviser, and Kenneth Rogoff, who was chief economist at the International Monetary Fund. They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations. It might also help the economy by encouraging Americans to spend now rather than later when prices go up.

“I’m advocating 6 percent inflation for at least a couple of years,” says Rogoff, 56, who’s now a professor at Harvard University. “It would ameliorate the debt bomb and help us work through the deleveraging process.”

Such a strategy would be risky. An outlook for higher prices could spook foreign investors and send the dollar careening lower. The challenge would be to prevent inflation from returning to the above-10-percent levels that prevailed in the 1970s and took almost a decade and a recession to cure.

“Anybody who has been a central banker wouldn’t want to see inflation expectations become unhinged,” says Marvin Goodfriend, a former official at the Federal Reserve Bank of Richmond. “The Fed would have to create a recession to get its credibility back,” adds Goodfriend, now a professor at Carnegie Mellon University’s Tepper School of Business in Pittsburgh.

Preventing Deflation

For the moment, the Fed’s focus is on preventing deflation -- a potentially debilitating drop in prices and wages that makes debts harder to repay and encourages the postponement of purchases. The Labor Department reported May 15 that consumer prices were unchanged in April from the previous month and were down 0.7 percent from a year earlier.

Sounds right to me, assuming that the Fed can actually control inflation at the desired level. I don't know how much control they actually have. Assuming that the Fed wanted 6% inflation +/-1% or so, could they reliably do that and keep inflation in the desired range?

 

[drkitten]

Sounds right to me,

It does make a certain amount of sense, yes.

assuming that the Fed can actually control inflation at the desired level. I don't know how much control they actually have. Assuming that the Fed wanted 6% inflation +/-1% or so, could they reliably do that and keep inflation in the desired range?

No. Especially not in the current economic climate.

Inflation is a product both of the amount of money in circulation and of its speed of circulation. As soon as people start to expect inflation, they'll start spending it much faster in order to make use of it while a dollar is still worth something. Since the Fed has no control over public opinion and therefore over consumer spending, the odds of them being able to hit any specific distant target like that are very small.

Especially since they've more or less run out of subtle ways to adjust the inflation rate; at this point all they have left is to fire up the printing presses, create zillions of dollars of new money, and hope that they get the supply right.

 

[pgwenthold]

Especially since they've more or less run out of subtle ways to adjust the inflation rate; at this point all they have left is to fire up the printing presses, create zillions of dollars of new money, and hope that they get the supply right.

But isn't that effectively what the stimulus packages have done? Dump a whole bunch of money into the economy? Or does the interest they pay on it temper the effect?

 

[drkitten]

But isn't that effectively what the stimulus packages have done?

That's certainly an effect, but it's not the primary one.

As "Helicopter" Bernanke pointed out, it's very easy simply to dump money into the economy. But the trick is to determine how much you need to dump, and that's a very hard calculation to make accurately.

The stimulus packages are trying to achieve the same effect with a closely targeted and much smaller pile of money. One key problem the world economy has been facing, for example, is a tremendous shortage of money available for credit (i.e .that banks are willing to lend out). Rather than giving everyone in the US $2000 to play with, the government has targeted a pile of money at the banks so they can loan the government's money out instead of their own.

Similarly, one of the problems is an absence of jobs, and simultaneously an absence of insfrastructure and infrastructure funding. Put these problems next to each other and the solution is obvious -- pay people to build needed infrastructure.

If you do this right, then (hopefully) the economy will recover without needing to resort to heroic inflation.

 

[Brainster]

U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff



Sounds right to me, assuming that the Fed can actually control inflation at the desired level. I don't know how much control they actually have. Assuming that the Fed wanted 6% inflation +/-1% or so, could they reliably do that and keep inflation in the desired range?

I don't know about +/- 1% but certainly the Fed has kept inflation remarkably consistent over the last 25 years.

There are several problems that I can see. First, the government is going to be marketing a lot of bonds, notes and bills in the marketplace over the next several years in order to finance the Obama deficits; the more inflation the market anticipates, the higher the interest rate it will demand from the Treasury. Basically, for every 1% higher the anticipated inflation rate is, the interest rate goes up by 1% as well. If we say that the 6% inflation rate is roughly 3% higher than the inflation rate we saw for much of the 1984-2007 period, then we should anticipate a 3% premium on the interest rates we pay. And on $1.8 trillion in new borrowing, that's $54 billion in additional annual interest charges. That's just on the new borrowing for this year, that's not considering the regular Treasury refundings or next year's deficit.

 

[drkitten]

And on $1.8 trillion in new borrowing, that's $54 billion in additional annual interest charges. That's just on the new borrowing for this year, that's not considering the regular Treasury refundings or next year's deficit.

Shrug. That would be peanuts if the effect of the inflation (more accurately, of the increased money supply) were to allow the GNP to grow at, say, 12% a year (6% greater than the assumed inflation, reflecting a "real" 6% growth per year.) Inflation by itself is not a problem -- any more than it's a problem that I have to use bills with pictures of dead presidents at home, but I use "notes" with pictures of the Queen when I visit London.

But the only conditions under which I see that rosy picture as being likely are a tremendous shortage of exchange and investment capital or a serious deflation, neither of which appear to be the case right now.

 

[Puppycow]

Shrug. That would be peanuts if the effect of the inflation (more accurately, of the increased money supply) were to allow the GNP to grow at, say, 12% a year (6% greater than the assumed inflation, reflecting a "real" 6% growth per year.) Inflation by itself is not a problem -- any more than it's a problem that I have to use bills with pictures of dead presidents at home, but I use "notes" with pictures of the Queen when I visit London.

But the only conditions under which I see that rosy picture as being likely are a tremendous shortage of exchange and investment capital or a serious deflation, neither of which appear to be the case right now.

Oh yeah, good thinking.
He had me worried there for a second, but I think that what you are saying is that, yes, we would be paying more on a nominal basis, but not on a real basis, right?

Still, there is a concern that the Fed might not be able to keep inflation in the Goldilocks range.

I wonder if allowing more immigration would help the real estate market?

ETA: The difference between real wages and nominal wages (and how most people can't grasp the concept) is cleverly illustrated in this chapter of A Connecticut Yankee in King Arthur's Court, by Mark Twain

 

[drkitten]

Oh yeah, good thinking.
He had me worried there for a second, but I think that what you are saying is that, yes, we would be paying more on a nominal basis, but not on a real basis, right?

Yup.

Still, there is a concern that the Fed might not be able to keep inflation in the Goldilocks range.

Absolutely.

I wonder if allowing more immigration would help the real estate market?

Almost certainly. (Personally, I think there are rather few economic problems the USA is currently facing that allowing more immigration wouldn't solve. This includes unemployment.)

 

[quixotecoyote]

Almost certainly. (Personally, I think there are rather few economic problems the USA is currently facing that allowing more immigration wouldn't solve. This includes unemployment.)

At the risk of a derail, I'd like to see your line of reasoning here.

 

[drkitten]

At the risk of a derail, I'd like to see your line of reasoning here.

More people = more demand for services = more jobs for people providing services = lower unemployment.

Economics isn't a zero sum game; specialization makes it a positive-sum game. We both save time and money if we specialize -- I'll mow your lawn if you repair my roof. We save money because we need only buy one set of equipment (you don't need a lawnmower, and I don't need a ladder), and we save time because I become more skilled at mowing lawns and can do it more effectively. We use the additional time and money to create more wealth, which allows both of us to put in a pool and hire a pool contractor to take care of it.

 

[Emperor_Gestahl]

My issue with inflation

Wouldn't any inflationary measures further devalue the bond holdings of the banks, bond holdings that the banks are already unwilling/unable to carry at fair value?

They can keep holding them at book value for eternity but they might as well copy the bonds onto stone tablets with all the liquidity their "assets" would have under significant inflation.

From my layman's perspective the fed is trapped between a rock and a hard place, further cripple the banking system with inflation or risk bank runs and hoarding with deflation..

 

[Puppycow]

I don't follow what you are saying.
The "toxic assets" held by the banks are, I believe, CDOs, not bonds.
Inflation would presumably help, not hurt the value of those assets, which are based on real estate. Inflation would help the real estate market bottom out and start rising again. Wage inflation would make it easier for wage earners to pay off their mortgages. This would reduce defaults and improve the value of CDOs.

 

[corplinx]

I don't follow what you are saying.
The "toxic assets" held by the banks are, I believe, CDOs, not bonds.
Inflation would presumably help, not hurt the value of those assets, which are based on real estate. Inflation would help the real estate market bottom out and start rising again. Wage inflation would make it easier for wage earners to pay off their mortgages. This would reduce defaults and improve the value of CDOs.

Nobody is handing out wage increases in this economy. Recovery first, then we get raises again.

 

[drkitten]

Nobody is handing out wage increases in this economy.

Not true. Wages increases are based on what you can negotiate -- I negotiated myself a pretty sweet raise via external funding, and my sweetie got one through collective bargaining.

Even in this economy, workers won't work for free. If you want to retain talent, you need to pay what that talent is worth -- and if we start to see inflation, that will apply to talent as well.

 

[Francesca R]

The "toxic assets" held by the banks are, I believe, CDOs, not bonds.

You can think of them as bonds that have defaulted in some cases and which everybody expects will default in other cases. It is the expectation of default which has cratered their market value.

Inflation would presumably help, not hurt the value of those assets, which are based on real estate. Inflation would help the real estate market bottom out and start rising again. Wage inflation would make it easier for wage earners to pay off their mortgages. This would reduce defaults and improve the value of CDOs.

Wage and property inflation will not bring about recovery in bonds where the underlying assets have already been fire-sold or the underlying borrowers have walked away delinquent. It could in cases where that has not happened. The problem is that in the worst instances you would probably need American house prices to rise by 100% to get the bonds back to par value, which is not going to happen.