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Worrying about inflation

Current Inflation Rates - Monthly and Yearly Chart, Graph and Table- 2000-2009 Data - US Inflation Calculator_1258390308967.jpg

The main argument of Bruce Bartlett's book “The New American Economy” is that economic policies that work for one set of conditions don't work for another, but that people aren't very good at changing their ideology when the circumstances demand it. Supply-side economics, he argues, was a pretty good response to a period of inflation, like the 70s, but would be a terrible response to a deflationary moment, which is what we're in. But the economy changes a lot faster than minds do.

You're seeing some of this in the rampant fears of inflation. Worrying about inflation right now is tantamount to worrying that we're going to have an economic recovery. Unemployment is in the double digits, and it's rising. Credit markets remain sluggish. Output remains low. For inflation to pick up -- particularly in the absence of a major price shock, like oil skyrocketing -- we'd likely need those factors to reverse: Output would have to increase fast enough that employment and wages increased fast enough that prices began rising. That bring its own problems, but problems that we would prefer.

But the central banks don't really see it that way, and nor do some economic commentators. Part of the reason, I'd argue, is that there's still a hangover from the last serious economic crisis, which was driven by inflation. Back then, inflation was the problem. Right now, it isn't. A solution that risks some inflation but has a better chance of ending deflation and kick-starting the economy is a good solution. But that cuts sharply against the instincts of a lot of very smart people who became very smart at a time when inflation was to be feared.

Graph credit: US inflation calculator

By Ezra Klein  |  November 16, 2009; 11:58 AM ET
Categories:  Economic Policy  
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Comments

See Krugman's post of this morning. If you apply the Taylor Rule, the Fed Funds rate should be negative 6%. We are a long ways til full employment and til having to worry about inflation.

Posted by: scott1959 | November 16, 2009 12:19 PM | Report abuse

"people aren't very good at changing their ideology when the circumstances demand it"

Thank Lord Paul Krugman has given up on his another Trillion dollar stimulus and has started to talk what can we do for direct intervention to reduce unemployment at lesser cost. So I would say at least one leading economists may show the dexterity to change.

What about you Ezra? Any chance to ditch this 'coverage at all cost' view? Or quitting 'poor cannot wait till the cost curve is bend'?

Say what at least I read change in your coverage of GOP. Few months back, it was all about how a death spiral that party is in and now you are worried that whether GOP is ready to increase taxes or not as if you accept the possibility of GOP romping back. That is good. If the current Dem performance is continued, it is given that GOP will get back. It is up to "people" managing Dem affairs to change their rigidity of views.

Posted by: umesh409 | November 16, 2009 12:47 PM | Report abuse

i agree that the inflation panic, which is really a variation of deficit panic, is highly misplaced, but we could have inflation without a substantial recovery.

the issue would be the falling value of the dollar: if the dollar falls considerably more and, as a result, import prices rise, we could see a creeping upward of inflation while remaining trapped in a low-growth at best environment.

higher interest rates would offset the dollar fall, but at the cost of making the economic climate even worse.

which is how a term like stagflation first came into existence.

now, i'm not saying any of this is likely in the near term, but i wouldn't want our host to think that the only way we could have inflation is as a result of a robust recovery putting a super-charged demand push on the economy.

Posted by: howard16 | November 16, 2009 1:00 PM | Report abuse

Wait, inflation was the overriding concern during the dotcom burst?

Posted by: adamiani | November 16, 2009 1:01 PM | Report abuse

There is not legitimate Inflation Panic nor Deficit Panic. There is only Culture War causing the noise....

Posted by: JkR- | November 16, 2009 1:14 PM | Report abuse


The issue is U.S. government debt. If you can't pay it off, then other nations have you by the string.


Posted by: RandomWalk1 | November 16, 2009 1:55 PM | Report abuse

They are worried about missing out on deflation, which is an excellent opportunity to greatly reduce 'labor costs'.

Posted by: yoyoy | November 16, 2009 3:52 PM | Report abuse

I agree with the main point of your post, right now it is insane to worry about inflation being too high (it is sane to worry about possible deflation). I also very much agree with Bartlett's general claim that " policies that work ... the circumstances demand it." It applies to policies in general not just economic policies (it was insane to threaten to veto a bill which shifted money from missile defences to anti-terrorism in fall 2001).

However, I disagree with one of Bartlett's claims and 2 of yours. First he claims that supply side economics was a good appraoch to stagflation. I don't see how that can possibly be reconciled with the evidence. If he had said that tight monetary policy was a good approach, he would have an arguable case.

Cutting taxes to fight inflation makes no sense. Of course I don't expect him to admit this, but the comparison of the 80s and the 90s provides very strong evidence that Clinton's decision to reverse as much of Reagan's tax policy as was possible was an excellent choice.

The 70s inflation was clearly stopped by tight monetary policy not loose fiscal policy. I doubt you can find a respectable economist who would deny that Volker deserves more of the credit (or blame) for the deflation than Reagan.

You claim that central bankers "don't see it that way." This would only be true if you don't consider Ben Bernanke. The Fed's policy is the most wildly expansionary policy in its history and the most expansionary policy in any developed country at least since WWII. The federal funds rate is essentially zero and the monetary base was tripled. This was not enought, but it is just not true that Bernanke held back on monetary expansion for any reason including fear of inflation.

Finally you say that inflation was the problem in the 70s and the source of other problems. This was the popular perception, but that doesn't mean it is true. What damage did inflation (as opposed to the ferocious effort to fight inflation) do to the US economy ? What is the evidence for your view that inflation (rather than the Volker deflation) had costs which were not dwarfed by, say, the cost of a recession ? Is there any ?

Posted by: rjw88 | November 16, 2009 10:12 PM | Report abuse

We should be concerned about Unemployment, not Inflation. Societally we should be doing everything possible and whatever is necessary to lower the unemployment rate. Deflation is a greater concern than inflation.

The folks who are trumpeting these concerns about current deficits are off-base as well. The impact of deficits is grossly exaggerated by the national press. The current situation is much more analogous to that of 1932-33 than it is to the economic crisis of 1979-1982.

It is true that long-term structural deficits pose a problem that eventually must be dealt with, but we should not be worried one whit about deficits until we actually experience an economic recovery. We need to get back closer to full employment---at least get the unemployment rate below 7% and the under-employment rate reduced to around 12% (it is currently around 17%)---before we try to attack the deficit.

Choosing to cut the deficit rather than to promote economic growth is to choose the path of stupidity, and a path which will bring only more human misery. The American people are owed intelligent solutions, not wrong-headed stupid solutions which promote human misery.

Posted by: OHIOCITIZEN | November 17, 2009 12:36 AM | Report abuse

So. Ezra, how do you get the WP to start writing about this stuff? Steve Pearlstein seems to be a member of the reality-based community. Can't you and he do a series of stories on this? I'd promise not to cancel my subscripion again!

Posted by: racheljl | November 17, 2009 12:33 PM | Report abuse

Sigh. As I've pointed out before, world-class economists have 180 degree disagreements on these issues. Presumably y'all don't know any more than they do. So why pretend?

Posted by: MikeR4 | November 17, 2009 1:34 PM | Report abuse

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