Why Aren't the Democrats Just Advocating Inflation?
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.
I feel like your last couple of paragraphs accurately reflect the fears of the people, but you are being far too skeptical about those fears. When you say “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,” I ask you— what is your evidence that growth will bring wages back up? We’ve just endured decades of rising growth with stagnated wages. Why would people believe that anything else is going to happen?
Value that was historically captured by labor in the form of higher wages has since the dawn of the neoliberal policy regime instead been captured by capital, and any return to the status quo of a “healthy” economy is going to do the same thing. That’s not a narrative that is savvy, or flattering to those who want to believe that we don’t have fundamentally antagonistic relationships between our social classes, but it has the benefit of being true. People are merely being empiricists and making reasonable inferences from recent history.
— Freddie · Mar 1, 06:13 PM · #
Freddie: I didn’t intend to be skeptical about their fears. Not sure what I said that read as skepticism.
— Noah Millman · Mar 1, 06:24 PM · #
Freddie,
I’m starting to question my faith in corporate America, and what interests and incentives they have to towards the American worker. I know you are a big advocate of labor and unions, but I don’t think union participation will ever be significant in this country again. Also, given that most of this angst is felt by white collar tpyes where unionization isn’t an option, what is your best solution?— vaildog · Mar 1, 06:50 PM · #
Dunno.
— Freddie · Mar 1, 07:08 PM · #
Noah and Freddie,
But as my buddies at GMU will never tire of telling you, stagnating wages does not mean that living standards are similarly stagnating — as Noah explicitly acknowledges, compensation has not stagnated because health care costs have risen paying for all sorts of fancy new procedures making the quality of life for those workers Freddie is so concerned about better.
In addition, those workers are (or should be) increasingly investing in capital (especially real estate) so they are enjoying those increasing returns on capital that the cigar chomping, mustachioed-twirling capitalists are enjoying. Of course, we are all enjoying cheaper goods and services thanks to our global economy and (take a deep breath Freddie) free trade.
The guy to read on monetary policy is Scott Sumner: http://www.themoneyillusion.com/
— Jeff Singer · Mar 1, 07:23 PM · #
Jeff:
Unless I’m missing something, Scott Sumner is advocating nominal GDP targeting. The components of nominal GDP are inflation, productivity growth, and population growth. Unless he’s found a way to manipulate productivity growth or population growth by printing money (or withdrawing liquidity, if nominal GDP growth gets too rapid), the way he’s going to influence nominal GDP growth is by influencing inflation (or, better, inflation expectations).
The difference between NGDP targeting and inflation targeting, besides debate about whether you can actually observe inflation, is that real growth rates affect NGDP. So if real growth is strong, and inflation is low, Scott Sumner would say: keep money tight, because NGDP is strong. But if real growth is negative, and we have positive inflation, Scott Sumner would say: start up the printing presses – NGDP is too low.
In other words, in a situation where we already have inflation, but still have weak growth, such that NGDP is anemic, Sumner would advocate more inflation.
Do you agree?
— Noah Millman · Mar 1, 07:48 PM · #
Noah,
Agreed. Sumner is basically advocating the same thing Matt Y. is advocating. I just think he does it better.
— Jeff Singer · Mar 1, 10:36 PM · #
compensation has not stagnated because health care costs have risen paying for all sorts of fancy new procedures making the quality of life for those workers Freddie is so concerned about better.
No, a huge portion of higher health care costs are reserved for end of the life care of the very elderly. But nice hand waving about one of the biggest problems facing our country.
— Freddie · Mar 1, 11:44 PM · #
“It’s not memories of the inflation of the 1970s. Nobody remembers the 1970s anymore.”
The kind of people who vote in midterm elections have long memories. If the median voter in the 2010 elections was 50, he or she would have been 20 in 1980, when Jimmy Carter lost in large part due to inflation.
— Steve Sailer · Mar 2, 04:53 AM · #
By the way, William Jennings Bryan ran on an inflation platform in 1896.
He lost.
— Steve Sailer · Mar 2, 10:00 AM · #
No, a huge portion of higher health care costs are reserved for end of the life care of the very elderly. But nice hand waving about one of the biggest problems facing our country.
Which plays nicely into Robert Reich’s final solution. Death Panels were in, then out, then in, now out. Put them back in and a huge portion of the higher health care costs just go away.
— jd · Mar 2, 02:08 PM · #
If I understand the foundations of new Keynsianism correctly, it’s that “sticky wages” and “sticky prices” prevent wages and prices from dropping during a recession, and that monetary stimulus, by increasing inflation, can correct this problem. (Krugman’s old Slate article on the Babysitter Collective explains this really well, IIRC).
Krugman’s main current argument, if I understand it correctly, is that inflation would be great but that the Fed either can’t or won’t create it.
— J Mann · Mar 2, 04:23 PM · #
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.
Noah, were you by any chance born yesterday? This reasoning is just plain silly. Example: People in Russia have nostalgia for the days of the Soviet Union, and who can blame them for remembering their youth with fondness. That doesn’t mean they want the political system with all the stagnation and repression back. Some do, but that doesn’t mean others don’t separate out different things that happened in the 1970s.
As to the idea that the solution to recession is inflation, I can see why the Democrats would want that. According to David Hackett Fischer, the major periods of inflation in the western world have coincided with periods when the rich got richer and the poor got poorer. So such a policy would be entirely consistent with the whole of Democrat policy.
— The Reticulator · Mar 2, 04:59 PM · #
By the way, William Jennings Bryan ran on an inflation platform in 1896. He lost.
Back in those 1970s that Noah says nobody remembers, I asked my grandfather, at whose knee I had learned much of my conservatism, which presidential candidate he first voted for. I about fell off my chair when he said Williams Jennings Bryan. This was the grandfather who never reconciled himself to FDR and the New Deal, and who refused to accept social security despite living in curmudgeonly poverty, until the welfare pimps didn’t give him any other choice. Unfortunately I didn’t ask him any more about his first choice of presidential candidate. It wasn’t in the 1896 election, though. He wasn’t old enough to vote back then. But what he told me helped me think about populism on the Great Plains and in America. I think he and his father, with whom he kept up running arguments long after the father was dead, had been involved in some of the populist agitation against railroad monopolies in the first decade of the 20th century.
— The Reticulator · Mar 2, 06:06 PM · #
Sorry for 3 posts in a row, but I just realized that as part of my riff I should say that I remember the 1890s like they were yesterday. But it’s through my grandfather’s stories of those days, which I heard over and over. Some of them have to do with the big depression early in that decade and the homeless men who used to come through their rural Minnesota community. And there were the memories of the McKinley assassination — well, I guess that gets into the next decade.
— The Reticulator · Mar 2, 06:25 PM · #