Krugman, Interest Rates, Inflation and stuff

[Kurt_and_Hunter]

Paul Krugman is pro-inflation these days. Has been for a while now.

That sounds like being pro-malaria but inflation is, like most things, not all good or all bad. It depends on your situation. For instance, taking the usual extreme example of post WWI German hyper-inflation where a sandwich cost a billion marks... the guy with the wheelbarrow full of currency probably paid off all his outstanding debts long ago. His house, a pre-inflation fixed-rate debt, only cost as much as a sandwich! Bad for banks but good for debtors. In a nation like ours where the biggest economic problem is existing mortgage debts being higher than the current value of property some inflation--not billion dollar cheeseburger inflation, but more than we have--would not necessarily be unwelcome.

Inflation hurts money, specifically. Capitalists hate it because it lowers the relative worth of idle capital.

It is a useful generalization to view 1935-1980 as an inflationary period and 1980-today as a relatively flat/deflationary period. It is also a useful generalization to view 1935-1980 as a period of real wage-growth and post-Reagan world to have been a wage flattening period.

But I digress...

What I wanted to mention is how inflation fits into Krugman's work on a zero-bound trapped economy. When a central bank in a declining economy lowers interest rates to zero it loss the ability to further influence the economy through interest rates. You cannot sensibly go lower than zero.

What makes this current economy so perilous is that inflation was so low going into it. Krugman's general thinking is that if it were not for the zero-bound the Fed would have kept cutting rates down to about -5%. The early-1980s recession was deep and violent but it was a reigning in of inflation so rates were high at the start and the Fed had plenty of room to keep cutting.

Krugman's prescription for Japan in the 1990s and for us today is for the central bank to keep interest rates at zero for years while allowing some inflation to develop in the economy, and to let everyone know that's the plan.

In absolute terms when you need a cheap money policy you cannot get any cheaper than zero%, but in relative terms cheap money is cheap relative to inflation. Zero% sounds great but when inflation is barely 2% it's really not all that cheap. It lacks stimulative power.

For instance, say you're buying a house. You can get "great" mortgage rates these days, but how great are they? If the house is going to decline in value then even a 0% mortgage will quickly have you under water. But a 4.5% mortgage is great if you expect housing to appreciate, even in inflated dollars. (You will be paying the mortgage back in inflated dollars so it all evens out.)

So, crazy as it sounds to tea-baggers and CNBC talking heads, the only way to have the cheap-money environment we desperately need to to make that zero% cheaper in relative terms. And once you reach zero% only inflation can do that.

I am posting this because Krugman's columns and blog-entries often reference the need for inflation and it's useful, when reading him or any of the many like-minded folks who think money isn't cheap enough to spur the economy, to remember that it is the zero-boundary on interest rates that makes inflation attractive.

It's not that inflation is intrinsically *good*--it's usually destructive. This is a specific problem we face today that is unlike most economic down-turns.

[Vinnie From Indy]

1. That all might be true if Americans actually had jobs

No jobs - no consumption - no recovery.

[DJ13]

2. Add an inflationary spiral into that mix and no one will survive

Krugman needs to stop staring at his chalkboard and look at how the rest of the country is doing.

[depakid]

3. Better start getting your survival gear together, then

because as gas prices rise inexorably- the cost of everything else is going up, too- quite irrespective of whether the economy is "overheating"

[branders seine]

4. I agree that without jobs, the whole issue is moot.

But otherwise, nicely stated!