There is a very credible argument to be made that the only pro-growth policy worth talking about is increased monetary expansion until the price level catches up with prior trend – in other words: what we need is a good bout of inflation.
The argument basically runs like this. American consumers are struggling under the burden of too much debt. They are trying to get out from under this mountain by saving, rebuilding their balance sheets dollar by dollar. But they have also been terrified by the financial crisis into extreme risk-aversion in investing, and only want to put their savings into ultra-safe instruments like government debt. Meanwhile, inflation is very low and unemployment is very high. In spite of low interest rates, money is actually very tight. Additional fiscal expansion can’t work if monetary authorities cancel it out by tightening money further in response to rising inflation expectations. So, to get demand for goods and services up, we need to reduce the attractiveness of holding money. You do that by “printing” money until people take their money out of the mattress and either invest it in risky ventures with the prospects of a real return, or spend it on goods and services. Higher inflation will also reduce the real burden of the American consumer’s debts directly. Bottom line: we need more inflation. Matt Yglesias among others has been beating this particular drum for some time.
The main argument I’ve made in response is that because America both runs the world’s reserve currency and finances its massive budget deficits abroad, we cannot afford to be substantially looser than other central banks facing similar economic conditions. If the Fed explicitly aimed for 4-5% inflation for the next few years, while the ECB and BOJ stayed where they are, and the Chinese central bank tightened and cut its peg to the dollar to avoid importing that massive increase in American inflation, there’s a material risk that the dollar would lose its global reserve currency status in a precipitous fashion. It’s going to lose that status anyway eventually – but losing it suddenly and violently would have a sudden and very negative impact on the borrowing costs of any entity doing business in dollars, including the U.S. Treasury. That rise in borrowing costs would more than offset any benefit from the higher inflation policy.
That’s not a certainty of course, and coordinated action among the main global central banks would make a huge difference. But if I were a Fed governor, I’d be very reluctant to take that risk, even in the face of 10% unemployment.
But I doubt that the political salience of inflation fears – and those fears clearly are salient; check out the popularity of goldbug talk – is driven by this kind of analysis. So what is it driven by?
It’s not memories of the inflation of the 1970s. Nobody remembers the 1970s anymore. If they did, the phenomenon of 1970s nostalgia would never have occurred. And it’s just “folk economics,” though I think that’s a part of it.
I suspect that the political salience stems in part from the knowledge, on the part of most working people, that they have little to no bargaining power for wages.
Since the 1970s, wages have stagnated for most workers. Arguably, total compensation has not similarly stagnated, because the cost of health benefits has skyrocketed, but I don’t think that this increase in cost is perceived as a comparable increase in value. Prices, on the other hand, have been more volatile. We’ve had periods of high energy prices and low energy prices. Periods of high food prices and low food prices. And for some categories of goods – electronics, most prominently – rapid improvements in quality have gone hand in hand with stable or even declining prices. Prices, in other words, appear to be something reasonably subject to policy influence. Wages, not so much.
If you look at that experience, and ask yourself, “do I believe inflation will benefit me?” the obvious answer is “no.” The rational expectation of the American worker is that higher inflation will mean a higher cost of living – higher prices for energy, food, rent – but that wages will not keep pace. In other words, higher inflation means a lower standard of living. Why would you vote for that?
Particularly when, if you ask advocates of inflation what it would do to real wages, they have to admit: it would cause them to decline. The theory of what causes recessions that animates advocacy for inflation is that recessions are caused by the stickiness of wages. When demand falls, you want wages to fall to a new “clearing” level that allows business to continue to employ the workforce. That doesn’t happen, though, because wages are “sticky” – hard to cut. So, instead, you get layoffs and reduced output, and the economy settles at a lower level of activity. Inflation enables real wages to be reduced without cutting nominal wages, so you get to the clearing level more quickly with fewer layoffs, and the recession ends.
If you accept this theory, then it is ultimately better for everyone to accept a short-term drop in the standard of living (a decline in real wages) in order to return to growth, which will ultimately bring wages back up. But if you haven’t experienced rising wages very often in the past, why would you buy this particular pig in a poke? Why wouldn’t you be more inclined to think: you’re telling me the solution to our economic problems is to reduce my standard of living? No thank-you. If I’m going to have to reduce my standard of living, I’d rather do it voluntarily by saving more money. And I’ll be keeping my savings in gold, thank-you very much.