A Little Inflation Is a Good Thing

While we are mulling over memories of the riots of the 1960s, there’s another ghost from the past that is haunting domestic policies in the U.S.: inflation, or in the lethal combo experienced by Americans in the late 1970s, stagflation (rapidly rising prices but little or no employment growth).

People who weren’t adults in that era may have trouble identifying with the fear of inflation some grey-hairs exhibit. And the whole topic is complicated by the ancient oppression of debtors by creditors, who naturally prefer hard money and stable prices. Right now, however, the problem is that the financial community–not just in the U.S., but globally–has embraced a hard line on inflation that a lot of economists consider excessive and actively destructive, particularly in a fragile economic recovery like the one we are in right now. At the New York Times today, Benyamin Applebaum does a good job of explaining the conflict and the stakes:

The cardinal rule of central banking, in the United States and in most other advanced industrial nations, is that annual inflation should run around 2 percent.

But as the Federal Reserve prepares to start raising its benchmark interest rate later this year to keep future inflation from exceeding that pace, it is facing persistent questions about the wisdom of the rule and the possible benefits of significantly increasing its target….

The Fed’s policy-making committee meets in Washington on Tuesday and Wednesday, and officials are expected to discuss how much longer the central bank should hold its benchmark rate near zero, as it has done since December 2008. Officials had planned to start raising rates between June and September, but growth has fallen short of the Fed’s expectations this year, which could delay the liftoff.

Inflation has mostly remained well below the 2 percent target since the global economic downturn. The Fed’s preferred measure, published by the Bureau of Economic Analysis, rose just 1.4 percent during the 12 months ending in February.

But Fed officials want to start raising rates in anticipation of stronger growth and faster inflation. William C. Dudley, the president of the Federal Reserve Bank of New York, said last week that “hopefully” the Fed would make its first move this year.

So when the Fed resists or postpones calls for higher interest rates, it’s actually defending the existing 2% target, which conservatives would like to make even lower, at a time when a lot of economists think a higher target would be just fine.

Laurence Ball, an economist at Johns Hopkins University, proposed in a 2013 paper that central banks should adopt 4 percent inflation targets. The benefits of avoiding a return to the so-called zero lower bound, he said, outweighed the potential economic disruption.

“A 2 percent inflation target is too low,” he wrote. “It is not clear what target is ideal, but 4 percent is a reasonable guess, in part because the United States has lived comfortably with that inflation rate in the past.”

And beyond that debate, a lot of observers think the recovery will be unsustainable without some monetary stimulus:

Lawrence H. Summers, the former Treasury secretary, argues that the developed world may have entered a period of “secular stagnation” in which borrowing costs are unlikely to rise significantly above current levels because of chronic lack of demand.

Bankers are resisting such advice, then, out of a combination of habit, caution, and ideology. Indeed, as Applebaum points out, they claim keeping the 2% inflation target steady is itself a source of economic stability–sort of an elevation of “we’ve always done it that way” into dogma.

We need pressure not just from economists but from political folk on this subject. Yes, we do need to maintain the independence of the Fed, but that should also mean independence from precedents that have outlived their usefulness.

Ed Kilgore

Ed Kilgore, a Monthly contributing editor, is a columnist for the Daily Intelligencer, New York magazine’s politics blog, and the managing editor for the Democratic Strategist.