Deflating arguments for inflation
Proponents of increased government spending during economic slumps assume that the chief cause of slumps is insufficient spending. People cling to cash rather than buy products that improve their lives or invest in ways that expand their portfolios. The result is too little demand for workers.
And workers — for several reasons, some psychological — stubbornly refuse to make themselves more attractive to employers by accepting lower wages. Unemployment at $0 per hour is assumed to be more attractive to the typical worker than is working at, say, $20 per hour if that worker had until recently earned $21 per hour.
Economists say that wages are “sticky downward.” This downward stickiness of wages is a principal justification for mild inflation. By lowering the real value of the $21 paid hourly to workers, inflation cuts wages without workers noticing that their wages are being cut. So inflation (the argument goes) promotes employment.
Inflation sparks a virtuous cycle. With real wages cut by inflation, more jobs are created. More jobs mean more money in workers' pockets and more optimism in their hearts. Workers then spend more, creating even more jobs.
I grant the reality of wage stickiness — at least for many workers and for some finite period of time. But the proposition that inflation — here, a consciously engineered reduction in the value of the monetary unit — is an appropriate cure for economic slumps should be approached cautiously.
First, empowering a monetary authority to debase money for good causes is to empower it to debase money for bad causes. Discretionary monetary policy necessarily rests in the hands of human beings with monopoly power over the supply of money. And such power is an especially intoxicating elixir.
Imagine that you could print money, legally and at your own discretion. Do you think that you'd long resist printing money for your own convenience rather than exclusively to promote the public good? Do you know anyone who could be trusted with such power?
Yet such trust is the only “constraint” on the Federal Reserve's power.
History offers powerful evidence that this trust is misplaced. Since the Fed was created in 1913, the dollar has lost 96 percent of its value. By comparison, during the 123 years prior to 1913, the dollar's value fell by a mere 8 percent.
Another problem with using inflation as a “countercyclical tool” is that it initially transfers wealth from creditors to debtors. Debtors repay their loans with dollars worth less than the ones that they earlier borrowed.
Populists and “progressives,” who are roundly suspicious of anyone wealthy enough to make money by lending money, often celebrate this effect of inflation. Such celebrations, though, are naive.
When creditors come to realize that dollars in the future are very likely to have less purchasing power than dollars today, creditors will add an “inflation premium” to the interest rates they charge. This premium compensates creditors for the expected inflation.
In addition, because rates of inflation are impossible to predict with any precision, an inflationary policy introduces unnecessary uncertainty into the economy. Households, businesses and investors have to do more guesswork about the future. This added uncertainty is extra drag on the economy.
Donald J. Boudreaux is a professor of economics at George Mason University in Fairfax, Va. His column appears twice monthly.
Show commenting policy
TribLive commenting policy
- Port Authority police discuss bus crash with county prosecutors
- Steelers notebook: Tomlin bringing officials to practice
- Rossi: Pirates plan to carry Hurdle deep into playoffs
- Steelers’ Tomlin does not like his coaching style to be characterized
- Penguins notebook: Malkin picture muddy
- Pets rescued from Westmoreland house fire
- 35,000 walrus come ashore in northwest Alaska
- Melocchi pleads guilty in leading McKeesport gambling ring
- September ranks with driest ever in Western Pa.
- Flags lowered to mourn Pa. state trooper shot dead during gun training
- Threat leads to evacuation of Sandy Hook school