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Inflation Fixes Nothing
But it is easier than acting like responsible adults.


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Kevin D. Williamson

The New York Times has published a very interesting article forwarding a number of familiar arguments that the Federal Reserve should try to increase inflation in order to encourage economic growth. Without going too deeply into the fallacies behind the idea that higher inflation is a means to strong and sustained economic growth, it is worthwhile to examine the wishful thinking and euphemisms that inform the Times’s account.

Item 1: “Rising prices help companies increase profits; rising wages help borrowers repay debts. Inflation also encourages people and businesses to borrow money and spend it more quickly.”

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Let’s take a look at these claims in order. First, how do rising prices help firms to increase profits, and which firms do they help? The Times article mentions Walmart, which is a fine example. Walmart, as a retailer, is both a buyer and seller of consumer goods. Rising prices add to Walmart’s profits by increasing what consumers pay after enduring one of the company’s negligent and borderline hostile checkout lines.

The unspoken corollary here is that those higher prices charged to consumers are not matched or exceeded by higher prices paid to suppliers. Walmart has a great deal of market power, and it can very often force its suppliers, mostly smaller firms, to swallow some very bitter medicine. Also, Walmart and similar companies can, as the Times notes, raise prices while not raising wages, especially in the current weak employment market.

So, inflation adds to Walmart’s profits by lowering the real income of Walmart’s suppliers and by lowering the real wages of Walmart’s employees. It is amusing to contemplate the possibility of Janet Yellen’s calling a press conference to announce: “Our plan for improving the economy is to use monetary policy to help Walmart screw over its vendors and employees in order to increase its own bottom line.” In addition to being the sort of thing that nobody is inclined to say in public, it ignores the fact that all that really has been accomplished here is a wealth transfer, from smaller and less powerful firms to larger and more powerful ones, and from consumers to retailers. Maybe it is the case that $1 in Walmart’s pocket is growth-ier than $1 in my pocket or $1 in General Mills’s pocket, but I am not familiar with any evidence for that proposition.

As for the second part — that rising wages help borrowers pay debts — that is undoubtedly true. It also means that lenders get paid back in money that has less value, which again is just a wealth transfer from X to Y. Functionally, it is no different from simply passing a law that everybody’s outstanding credit-card debt has to be reduced by 20 percent or their car loans and mortgages forgiven. Somebody gains, somebody loses, and there’s no straightforward path to growth. Yes, consumers will spend the money that they were going to use to pay down their debts on something else, but their creditors will have less money to spend on the things that they might have purchased. It’s a zero-sum transfer.

No doubt the third claim, that inflation encourages borrowing and spending, is true: If I knew inflation were going to 10 percent tomorrow and I could borrow money at 5 percent today, I’d borrow all the money I could and spend it on things that I want before the prices go up. If debt-financed spending on stuff we couldn’t otherwise afford were a healthy thing, then the housing bubble should have made us all richer instead of poorer. But that didn’t work out that way.

Item 2: “Inflation also helps workers find jobs, according to an influential 1996 paper by the economist George Akerlof and two co-authors. Rising prices allows companies to increase profit margins quietly, by not raising wages, which in turn makes it profitable for companies to hire additional workers.”

This is a variation on the Walmart employee situation described above. What this means in plain English is: If you lower workers’ real wages, then there will be more demand for workers. Again, there is no doubt that this is true: Demand curves slope downward. But if you want to lower Americans’ wages, you should just say so — and there are easier ways of lowering wages than inflation.

You could abolish the minimum wage, for example, or mandate a 20 percent pay cut for government workers, or — as our friends at the Chamber of Commerce would like — expand the labor supply by importing millions of low-wage workers. You could repeal the National Labor Relations Act and Davis-Bacon. Again, I like to imagine the press conference, with President Obama proclaiming: “Let me be clear: The key to our economic success is ensuring that Americans are paid less.” I will not hold my breath waiting for that to happen.

Inflation is a nice option for policymakers who don’t have the guts to say what they really mean, which is that they think the economy would be better off if Americans had more debt and lower wages, and if wealth were transferred from people who save money to people who borrow money. (It is easy to see how the latter would appeal to the powers that be in Washington.)

But if you take a moment to appreciate one of the difficult facts of economic life — that production always precedes consumption, for the simple reason that you cannot consume what has not been produced — then goosing aggregate demand looks like what it is: political game-playing that attempts to paper over the real problems in the economy.

The alternative is creating an environment of stable prices, predictable regulation, and responsible governance, all of which are necessary to encouraging long-term investment, which is where real wealth-creation comes from. That’s a lot harder and doesn’t seem nearly as clever as asking the geniuses at the Fed to inflate away our economic troubles. But it is the only path to long-term prosperity.

— Kevin D. Williamson is roving correspondent for National Review.



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