The “Inflation Solution”

by Ramesh Ponnuru

In the New York Times Magazine, Adam Davidson argues that the Fed should increase inflation because it would spur consumer spending. Consumers would spend more because unspent money would dwindle in value. But what the Fed would actually be doing if it adopted an effective expansionary policy is increasing nominal spending, which would partly take the form of rising inflation and partly take the form of higher real economic growth. Higher growth means higher returns, which also causes people to invest more. That’s a good thing, not a bad thing, but because Davidson doesn’t see it he undersells his own argument. He also makes it politically weaker, since a Fed that wants to raise real incomes is likely to be more appealing than a Fed that wants to lower real incomes. (Just guessing.)

With this point in mind, I’d also make a friendly amendment to Josh Barro’s short item in the Times on this subject. He writes, “A shift to nominal G.D.P. targeting, advocated by a vocal group of economists on the right and left, would result in a healthy near-term boost in inflation. This would help fix American balance sheets, because inflation reduces leverage — loans are in nominal dollars, so inflation reduces borrowers’ real debts. More importantly, such targeting would put people back to work and spur faster real economic growth.” I’d be delighted if the nominal-spending boost completely took the form of growth in real income; it’s not the boost in inflation I’m looking for. Balance sheets would still improve, because higher nominal incomes would increase asset values.

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