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Is inflation our friend?

The more I watch our political system work -- which looks curiously like everything else looks when it's not working -- the more I think we're eventually going to inflate away a lot of our debt. Or maybe we'll default. Hard to say.

By Ezra Klein  |  February 17, 2010; 1:40 PM ET
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To be able to inflate away our debt, we'll have to reach full employment (unemployment rate of about 5%) in the foreseeable future - not a bad bargain as things stand now.

Posted by: pneogy | February 17, 2010 1:51 PM | Report abuse

not just our friend, but our only friend?

Posted by: bdballard | February 17, 2010 1:52 PM | Report abuse

Yay! Good time to hold a 4.75% mortgage...

P.S.: Hey Ezra: could you ask the Post to put a tip-jar on your page. I'd like to support your work financially, but can't actually bring myself to give any money to The Post Corp. Thanks!

Posted by: antontuffnell | February 17, 2010 1:56 PM | Report abuse

Ezra, here's some more fodder for the blog: GOP wants a televised jobs debate.

My initial take: this would be good for the GOP. I don't see the administration winning on the jobs argument, despite what the merits may say (and anyone who reads the Leonhardt article knows that the stimulus was effective, but that won't matter). The fact is, the Obama administration still fails to pin down its communication of how many jobs were saved or created (see Gibbs' press conference Tuesday, I believe). More significantly, 'jobs saved' may be the single worst political sales pitch phrase of the past generation. OK, perhaps I exaggerate, but it has to break top 5, easily, right?

Anyway, my point is that "it's the economy, stupid." The economy is lousy. The party in power gets the blame. That is politics 101. You mentioned in Twitter that the counterfactual should matter in political reporting. Well, it doesn't - except, that is, when the GOP claims their 'stimulus' (read tax cuts for the rich) would have created jobs. Then, people listen.

Lastly, a jobs debate obviously distracts from the health care issue. Would be just another setback for the administration if it wants to get HCR done.

Posted by: gocowboys | February 17, 2010 1:57 PM | Report abuse

yesh, inflation is our friend. We need to stop looking at inflation as a bogeyman to be afraid of.

Posted by: Quant | February 17, 2010 2:10 PM | Report abuse

Sorry, but inflation would only reduce the real value of our current nominal debt while dramatically increasing the cost of unfunded liabilities and make our debt worse. Social Security and Federal Retirment Benefits contain explicit infaltion adjusters. Medicare and Medicaid outlays are determined by costs at time of delivery. Inflation would also drive up interest rates making it more costly to roll over existing debt.

Posted by: WoodbridgeVa1 | February 17, 2010 2:11 PM | Report abuse

Wow, Ezra, that's a heck of a thing to casually say in a very short blog post! Has anyone informed the bond markets that US debt is going to be either defaulted on or inflated away? Who's going to be relaying that message to China, Japan, & South Korea?

Seriously, if you are actually right about this (and I'm not saying I disagree, unfortunately), then it seems to me that we are in huge trouble - like serious, run-for-the-hills caliber trouble.

Here's the $100,000 question though - what happens in the US when nobody will buy our bonds anymore? Should I be buying guns & land in the countryside?

Posted by: bridgietherease | February 17, 2010 2:27 PM | Report abuse

Inflation is your best friend if you owe a lot of money at a fixed rate -- like a home mortgage that you pay off. (Or a government that owes a lot of money. Hmmm.) Inflation is your enemy if you are a bank because that mortgage you made is paid back in currency worth way less than the 5% you are making on it.

Consider someone who bought a house in the '70's with a 6% mortgage and then lived through years of huge inflation. They made out great. (The banks/capital holders who lent to them did not.) But, if you have a $10M portfolio that's making 7% a year when the currency is being devalued at 8% a year, you are losing money.

It's a good issue for Republicans (in the bad sense of the term) to raise populist ire about (the price of bread is going up!) even though the people it hurts most is the wealthiest.

Posted by: BHeffernan1 | February 17, 2010 2:31 PM | Report abuse

Inflation isn't a long-term strategy. The choice isn't inflation or default - if we try inflation as 'the' solution for our deficit problem, then it's going to end in default (inflating away debt is in some sense default in any case). Bondholders aren't going to let us get away with it. First rates are going to go to 5%, then 7%, then 15%, and then we're going to see our bonds denominated in Euros, Yen, Renminbi (alternatively we might only be able to issues TIPS, although foreign lenders at that point might not trust our CPI), and then we're in Germany circa 1922, printing massive amounts of dollars to pay off crushing debts that we can no longer inflate away. Keep in mind I'm saying this as someone in favor of short-term reflation to get nominal sales back onto the long-term trend.

We should always ignore the siren call of inflation.

Posted by: justin84 | February 17, 2010 2:43 PM | Report abuse

A) Nobody is going st stop buying our bonds

B) we are not Germany circa 1922

this is all just bogeyman talk. Right now the rate on our bonds is the lowest in the world. How does that in any way jibe with "nobody will buy our bonds"

Posted by: Quant | February 17, 2010 2:49 PM | Report abuse

Ok, totally basic Econ 101 question here -- why is inflation necessarily a bad thing in this case?

I mean the fact is that the major reason that our economy has seized up (and banks aren't lending) is that there just isn't consumer demand out there. And the reason there's no demand is because everyone is "saving" by paying off all the unsustainable debt they took on over the past 10 years.

So if we need demand to get ANY sort of economic movement going again, why is inflation such a terrible thing? The problem isn't that new investment is too hard, it's that everyone has big personal debt. Wouldn't inflating it away actually kick start us into action?

Posted by: NS12345 | February 17, 2010 2:54 PM | Report abuse

Slightly higher inflation, say around 3-4% would be welcome. The FED would have more room to respond to future crisis and inflating away some of the debt would help both governments and debt ridden home owners.

Posted by: ideallydc | February 17, 2010 2:59 PM | Report abuse

Yes! Yes! the last two have it right!

Posted by: Quant | February 17, 2010 3:18 PM | Report abuse

Inflation might help existing homeowners on fixed rates, but God help those home-owners with adjustable rates, or people who want to buy homes in the future. Not to mention businesses needing loans, credit card debtors...

Posted by: WEW72 | February 17, 2010 3:30 PM | Report abuse


A) That's not true. Currently, investors are willing to buy our bonds. If we are stupid, we will have to pay more to issue bonds, and if we are really stupid, investors are not going to continue buying.

If we try to inflate our way out of debt, investors are going to demand higher and higher coupons, and if we keep inflating, they'll demand debt denominated in something other than dollars. In the extreme, our primary financiers might well walk away. Some inflation is okay. Generating ever more inflation for the sole purpose of paying down debt is a bad idea.

B) Right now, that is correct, because we aren't using the printing press to pay off debt.

The rates on USTs are not the lowest in the world either. Nations with lower inflation rates, such as Japan or Germany, pay lower rates.

Posted by: justin84 | February 17, 2010 3:56 PM | Report abuse

Ezra - Inflating away debt only works if your debts are long-term... If you are constantly rolling over short-term debt you just end up with new debt that incorporates the higher rates of inflation.

From the 2009 GAO report on the federal debt ( - good chart on page 13), "Of the marketable securities currently held by the public as of
September 30, 2009, $4,509 billion, or 65 percent, will mature within the next 4 years"

Posted by: hmg22 | February 17, 2010 4:02 PM | Report abuse

No one's suggesting that the debt be 100% inflated away. The point is that when weighing whether to go for full employment and inflation or unemployment and stable prices, inflation can be a good thing if you're in our situation: A) at the zero bound for interest rates and B) a net debtor. Raising the target level from 2% to 3% would do a lot of good.

Posted by: etdean1 | February 17, 2010 4:03 PM | Report abuse

You all have gone crazy! You can't put off hard budget decisions by relying on inflation. This is scary that some of you think inflation is a realistic answer.

justin84 is at least smart enough to know that long term inflation would be ruinous.

The fact is hard decisions need to be made including revenue raisers and serious and significant spending cuts in the long term.

There is no easy way out of this mess and please, please, please don't think you can find an easy way through inflation. That is a simpleton's arguement.

Posted by: lancediverson | February 17, 2010 4:05 PM | Report abuse

The long-standing 2% inflation target is correct. It allows the markets and individuals to plan for the future and make good decisions. If you start adjusting the inflation target, it really messes with the markets expectations.

Remember that if you are trying to trick someone, in this case, our creditors, to the benefit of the nation's treasury there is a horrible amount of collateral damage in that trick. Far too much damage to risk on that horrible scheme.

Posted by: lancediverson | February 17, 2010 4:09 PM | Report abuse

But surely it would take some pretty massive inflation to start shifting people away from UST's en masse, right?

I mean is it necessarily true that slightly-higher rates paid on UST's is more problematic than an economy frozen by a lack of demand? This is a serious question, I don't really know much about this stuff.

The point about ARM's etc... above is a good one but of course that's not the only kind of personal debt. There are millions of people limping along under healthcare debt, student loans, and other sources of personal debt that wouldn't blow up with inflation. If you really wanted to, you could even try and "bailout" the many people with credit card debts by offering them government loans fixed at whatever rate they're currently paying (and thereby shield them from that inflationary spike).

It just seems odd to avoid a tool that would devalue old debts in an economy where the major problem is that too many people are devoting too much income to paying those debts down.

Posted by: NS12345 | February 17, 2010 4:12 PM | Report abuse


Inflating away debt is all well and good for existing debt holders. Those of us who may want to take out a loan in the future or are trying to save aren't quite as thrilled.

Posted by: justin84 | February 17, 2010 4:14 PM | Report abuse

No one is seriously talking about inflating away the debt. At the same time, the concerns about "no one buying our debt anymore" are ridiculously overblown. It's fear-mongering. Our economy can withstand moderate inflation now; it would probably be helpful. And over the long run we need to control spending (cough, healthcare, cough). The tea party rhetoric about hyperinflation is completely bonkers

Posted by: Quant | February 17, 2010 4:36 PM | Report abuse


I'm okay with raising the inflation target from 2% to 3% in the short-run. I do think that part of our problems is that the Fed didn't fully accomodate a sudden surge in money demand in 2008, and reflation would help fix that problem. I would actually prefer to phrase it as a 2% level inflation target with 2008 as the base year, so that instead of shooting for 2% each year, the Fed shoots for a price level of 102 in 2009, 104 in 2010, 106 in 2011, etc. I think that lance makes a good point in that people make decisions around expected inflation, and having a central bank prone to change the rules at its own discretion creates uncertainty.

In the long run I want the Fed to get away from targeting interest rates and instead target NGDP futures, level targeting, at a level which generates low to zero inflation (2%-4% annual NGDP growth). See Scott Sumner's blog - The Money Illusion for more details (I found out about this concept from his blog).

I don't think an extra 1% of inflation is a way out of our debt problem when we have medium term deficits leveling out at 4% of GDP at the end of the decade, and long term deficits exploding. The rate of inflation to even attempt to do something about that would be, as lance puts it, ruinious.


Modest inflation, even if committed to for the long-haul, won't lead people to stop buying USTs. We will have to pay more to issue them, however. For a fixed level of debt, an increase in interest paid from 3% to 5% would require a cummulative 67% increase in the price level for real debt servicing costs to remain flat when it's time to rollover. For me, the cost of servicing the debt is more important than the level.

As for all the people who are limping under debt right now, inflation will create a new group of people in the future who will be limping under debt as well, but at higher interest rates. I guess the point I'm getting at is inflation isn't a permanent fix. It's basically just redistribution. To achieve a similar result, we could institute a 5% wealth tax and use the proceeds to pay down debtor's balances in a pro-rata fashion, but then interest rates would go up so that investors would be able to clear the wealth tax hurdle.

Posted by: justin84 | February 17, 2010 4:36 PM | Report abuse


I want to say that we are largely in agreement. Some inflation will help the economy recover, we are not currently in danger of "no one buying our debt anymore", and the tea partiers' arguments are often incoherent.

I don't want to be misconstrued as being in the tea party camp. I'm simply saying that our fiscal problems are not going to be solved by inflation alone, and if we try it's going to get ugly.

The article which reference 40% of the value of the debt from 1946-1955 or so being lost to inflation doesn't take into account that much of that inflation was related to the aftermath of WW2 and the Korean War, and people in those times generally expected stable prices outside of war - I don't think we could repeat the 1946-1955 inflation experience again and get away without much higher coupon rates on USTs (unless of course there is another big war or something similar).

I'm in favor of short-term inflation because I think we let nominal GDP diverge massively from trend for several quarters, and that divergance has caused lots of damage to real GDP and employment (in terms of the article referenced, I'm in Scott Sumner's camp). I want to catch back up to trend.

I also agree with Sumner that central banks shouldn't target interest rates, they should target NGDP futures. Targeting interest rates gets people unnecessarily concerned about the lower bound (I think its funny that the article suggest that the Fed needed to cut rates 3%-5% more - to me that suggests interest rate targeting is the problem, not that the rate of inflation is too low. You'd need a high rate inflation to avoid hitting the zero bound if you need to cut rates 7%-10% during some cycles).

Posted by: justin84 | February 17, 2010 5:09 PM | Report abuse

"Is inflation our friend?"

This is how you know you're on a liberal blog: 24 comments, and not one occurrence of "401(k)."

I guess it doesn't matter if Social Security is your retirement plan, huh?

Posted by: cpurick | February 17, 2010 6:04 PM | Report abuse

Oh, yeah, and "IRA" isn't here, either. Go figure.

Posted by: cpurick | February 17, 2010 6:06 PM | Report abuse

Or "savings." Another big surprise.

Posted by: cpurick | February 17, 2010 6:08 PM | Report abuse

"Or maybe we'll default."

La de da. No biggie as long as you get health care reform?

Sheesh. I hope it's you and yours and not me and mine going to have to fight the Chinese over a mere trifle like default.

Posted by: bgmma50 | February 17, 2010 9:10 PM | Report abuse

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