Some economists say a little inflation could be a big help
Inflation is widely reviled as a kind of tax on modern life, but there is growing concern that inflation is not rising fast enough. Some economists say more inflation is just what the American economy needs to escape from a half-decade of sluggish growth and high unemployment.
The New York Times
WASHINGTON — Inflation is widely reviled as a kind of tax on modern life, but as Federal Reserve policymakers prepare to meet this week, there is growing concern inside and outside the Fed that inflation is not rising fast enough.
Some economists say more inflation is just what the American economy needs to escape from a half-decade of sluggish growth and high unemployment.
The Fed has worked for decades to suppress inflation, but economists, including Janet Yellen, President Obama’s nominee to lead the Fed starting next year, have long argued that a little inflation is particularly valuable when the economy is weak.
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.
Retailers including Costco and Wal-Mart are hoping for higher inflation to increase profits. The federal government expects inflation to ease the burden of its debts. Yet by one measure, inflation rose at an annual pace of 1.2 percent in August, just above the lowest pace on record.
“Weighed against the political, social and economic risks of continued slow growth after a once-in-a-century financial crisis, a sustained burst of moderate inflation is not something to worry about,” Kenneth Rogoff, a Harvard economist, wrote recently. “It should be embraced.”
The Fed, in a break from its historic focus on suppressing inflation, has tried since the financial crisis to keep prices rising about 2 percent a year.
Critics, including Rogoff, say the Fed is being much too meek. He says inflation should be pushed as high as 6 percent a year for a few years, a rate not seen since the early 1980s.
All this talk has prompted dismay among economists who see little benefit in inflation, and who warn that the Fed could lose control of prices as the economy recovers. As inflation accelerates, economists agree that any benefits can be quickly outstripped by the disruptive consequences of people rushing to spend money as soon as possible.
Rising inflation also punishes people living on fixed incomes, and it discourages lending and long-term investments, imposing an enduring restraint on economic growth even if the inflation subsides.
“The spectacle of American central bankers trying to press the inflation rate higher in the aftermath of the 2008 crisis is virtually without precedent,” Alan Greenspan, the former Fed chairman, wrote in a new book, “The Map and the Territory.” He said the effort could end in double-digit inflation.
The current generation of policymakers came of age in the 1970s, when a higher tolerance for inflation did not deliver the promised benefits. Instead, Western economies fell into “stagflation” — rising prices, little growth.
Lately, however, the 1970s have seemed a less relevant cautionary tale than the fate of Japan, where prices have been in general decline since the late 1990s. Kariya, a popular instant dinner of curry in a pouch that cost 120 yen in 2000, can now be found for 68 yen, according to the blog Yen for Living.
This enduring deflation, which policymakers are now trying to end, kept the economy in retreat as people hesitated to make purchases, because prices were falling, or to borrow money, because the cost of repayment was rising.
“Low inflation is not good for the economy because very low inflation increases the risks of deflation, which can cause an economy to stagnate,” the Fed’s chairman, Ben Bernanke, a student of Japan’s deflation, said in July. “The evidence is that falling and low inflation can be very bad for an economy.”
There is evidence that low inflation is hurting the American economy.
“I’ve always said that a little inflation is good,” Richard Galanti, Costco’s chief financial officer, said in December 2008. He explained that the retailer is generally able to expand its profit margins and its sales when prices are rising. This month, Galanti told analysts that sluggish inflation was one reason the company had reported its slowest revenue growth since the recession.
Executives at Wal-Mart, Rent-A-Center and Spartan Stores, a Michigan grocery chain, have similarly bemoaned the lack of inflation in recent months.
Many households also have reason to miss higher inflation. Historically, higher prices have led to higher wages, allowing borrowers to repay fixed debts like mortgage loans more easily. Over the five years before 2008, inflation raised prices 10 percent. Over the last five years, prices rose 8 percent. At the current pace, prices would rise 6 percent over the next five years.
Inflation also helps workers find jobs, according to an influential 1996 paper by the economist George Akerlof and two co-authors. Rising prices allow companies to increase profit margins quietly, by not raising wages, which in turn makes it profitable for companies to hire additional workers. Lower rates of inflation have the opposite effect, making it harder to find work.
Companies could cut wages, of course. But there is ample evidence that even during economic downturns, companies are reluctant to do so.
Federal data show a large spike since the Great Recession in the share of workers reporting no change in wages, but a much smaller increase in workers reporting wage cuts, according to an analysis by the Federal Reserve Bank of San Francisco. There is, in practice, an invisible wall preventing pay cuts. The standard explanation is that employers fear that workers will be angry and therefore less productive.