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Higher inflation will save the economy

Posted by Marjorie Pritchard  March 2, 2012 02:09 PM

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By Rich Barlow

The Federal Reserveís recent announcement that interest rates will stay low for the next three years confirmed how sick the economy remains. The Fed simultaneously declared it would hold inflation to just 2 percent annually. But that policy also is looking sickly. What we need is higher inflation.

At a time when businesses blame their slow hiring on consumers shunning their goods, sticker shock may sound like Kevorkianomics. Yet itís not just some economists, including N. Gregory Mankiw, an adviser to George W. Bush, whoíve prescribed medicinal inflation during this recession. That best teacher of all, experience, suggests it could work.

Inflation helped end the two worst depressions in American history. Most people know that Franklin Roosevelt started jobs programs in the 1930s; fewer may recall that he also took the country off the gold standard to facilitate higher prices, which he declared good for the country. After the Great Depression, our grimmest economic crash was that of the 1890s, when unemployment approached 20 percent. We were on the gold standard then; the cavalry came to the rescue in the form of a string of gold strikes and improvements in gold refining. Both developments flooded the economy with gold; the money supply, prices, and prosperity mushroomed as a result.

Unlike todayís crisis, those depressions brought deflation, in which prices relentlessly plunge, neutering profits and spiking joblessness. But our Great Recession became great because, like the 1890s and 1930s, it came overlaid with a financial collapse-and now the Fed has confirmed that recovery will continue to be glacial, Januaryís heartening drop in unemployment notwithstanding. Long-term unemployment is at a six-decade high, and economists routinely couch talk of better times in caveats about how Europeís debt crisis could send our recovery AWOL.

Suppose the Fed were to announce a modestly higher inflation target, say, 4 to 6 percent? Advocates say that would stimulate the consumer demand in two ways. First, in any recession, there are people who could part with some disposable income but cling to it out of fear that the economy will stay bad, their job might be on the line, etc. The realization that that iPad or blouse theyíve been eyeing is going to be pricier in the near future would pry some of their dollars loose. Second, workers whose employers give cost-of-living raises would find their paychecks bigger, and some would spend the windfall.

Critics of this course include former Fed chairman Paul Volcker, who decries the "siren song" of easier money. Volcker fears that to be effective, inflation would have to run so long that the public would come to expect it as far as the eye could see, robbing it of any stimulative punch. Thatís what happened in the 1970s, when Volker, then head of the Fed, engineered a recession that finally strangled runaway inflation. But economist Paul Krugman argues that in a depressed economy, thereís more leeway to boost the money supply without prices going amok.

Others will complain that inflation erodes the value of savings, and Iím no happier about a haircut to my pension and my sonís college plan than the next guy. But we savers are getting clobbered with the Fedís eternally low interest rates, which analysts suggest wonít work anyway, since the problem isnít that moneyís too costly; itís that people canít afford to borrow or are afraid to spend with the outlook so gloomy. And if weíre worried about savers, how about some sympathy for those who canít save anything because they canít find a job?

Itís worth remembering that the late Milton Friedman, the conservative monetarist genius, gave unlikely praise to the populist William Jennings Bryan, whose 1896 presidential campaign proposed inflation to end that eraís depression. Barring optimistsí hopes for a real recovery, we may be singing a twist on Simon and Garfunkel in 2012: "Where have you gone, Jennings Bryan?"

Rich Barlow writes for BU Today, Boston Universityís news website.

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