Is moderate inflation good or bad?

[RandBlade]

Inflation generally is a Bad Thing. Especially high inflation and stagflation can have dreadful consequences. However deflation too is just as bad. So what's ideal? Perfect stability? Is moderate inflation (say 2-5%) actually that bad? Especially if it can be justifiably explained as a temporary phenomenon so it doesn't start push cycles of ever-inflating wages and more inflation. Moderate inflation can be a case where two wrongs make a right.

While in an ideal world a free economy should equilibrise to the right levels so that if prices are too high they come down, in the real world one of the biggest flaws is that simply doesn't happen easily. I'm no Keynesian [I think Keynes worked when government was as small as his days, but was not intended to be how his name is used now], but one think Keynes said that is definitely right is that prices and wages are "sticky downwards". Businesses have no incentive to cut prices when their costs come down normally unless their competitors do the same, while employees do not want to accept a cut in their wages.

Its far more possible and easy however to freeze prices. Management wage costs when our business were young got too high, so we never reduced them but did implement freezes. Inflation has helped reduce these costs. The government in the UK has today announced a third consecutive year of wage freezes for its employees - wages increased too far too fast in the good times leaving us a massive budget deficit that exploded in the recession, and they have not changed but by the end of the third year real wages will have come down by 10%. I don't think a 10% pay cut could ever have been agreed or enforced at any stage, but freezing costs and passing time allows it to happen.

Similiarly with debt, our debt burdens can become too high. If interest can be kept lower than inflation (a big if) then it allows a reduction in the real burden of that debt. My mortgage interest rate, like government bonds, is lower than the rate of inflation. As long as it can stay that way, as a taxpayer and a homeowner I'm happy.

I don't think inflation should be allowed to run out of control. Major inflation is definitely a bad thing. However if instead of 1% or 2% its 3% or 4% its not the end of the world. It may even be a good thing.

[wiggin]

A small amount of persistent inflation (1-3%) is a very good thing - it keeps people from holding onto their money in unproductive uses (e.g. stuck under the mattress), makes sure we aren't stuck in deflation, and is low enough we don't get stuck in the much-dreaded wage-price spiral.

Sticky wages is another issue inflation can help with, though frequently they can potentially lead to problems like stagflation if a labor market is rigid - with moderate inflation, it might take years for real wages to come down to an acceptable level, and during that time you can drag out a stagnation/recession due to labor market weakness (which is exacerbated by other problems, like housing in our current crisis). So moderate inflation helps sticky wages, but often it's only one piece of the puzzle.

As for debt, I don't view inflation as a way to get rid of debt. Assuming persistent moderate inflation (which is what monetary policy aims for, and what I would advocate for), this is factored into bond prices - sometimes explicitly in the case of TIPS, or implicitly by the market. Theoretically, then, in the long run inflation doesn't really reduce debt at all - in fact, if inflation gets to be persistently higher than target (I would consider anything above 3% to be 'high' for a developed economy), it will lead to something similar to a wage-price spiral, but rather an interest rate-debt spiral. Brief spikes above a target can be tolerated, of course, but in the long run, debt is here to stay absent outright default.

[RandBlade]

"In the long run" yes its priced in, but that's why I referenced temporary and moderate increases. We've had "temporary spikes" for the last 3 years now, that's devalued debt by 10% before interest - but interest has been low, lower than inflation.

Eg for the last few years despite the target being 2% inflation, we've had 3-4% and it peaked at 5%, I believe its 4.2% right now. My mortgage interest rate is 2.99% fixed, and when it switches to variable in a few months time my deal is "Base rate" (currently 0.5% still) + 1.49% so it'll be 1.99% interest with ~4% inflation. I currently have a real interest rate of -1% and it is going to -2%

[wiggin]

RB, I would consider the UK's inflation levels to be a bit risky right now. That's not to say it's a poorly managed economy - I fully understand the urge for early fiscal tightening, and your monetary policy has been broadly appropriate, given the circumstances. But inflation in the UK is dangerously high for a dangerously long amount of time. I think specifically because it's a decently managed economy and because of the unprecedented cyclical environment the UK has gotten a pass for now, but the BoE will have to convincingly reaffirm its commitment to inflation control once this is all over.

In general (not the UK in specific) if a country in debt ran high inflation for years in a poor fiscal environment, they'd be punished by higher rates on their debt. The temporary inflation spikes I was talking about should only last for a few quarters at most unless there is an unprecedented situation or an unprecedented amount of leeway given by the markets. In this specific case, there was, but in general I would say that higher than usual inflation won't significantly help a country's debt load without being punished disproportionately by markets.


I have heard arguments that many countries actually should be pursuing more inflationary policies right now - in fact, it can probably significantly improve employment, the housing situation, etc. There has been speculation that the BoE has informally adopted nominal GDP targeting - i.e. try to make monetary policy target a nominal GDP level rather than inflation. I fully understand the reasons posited for this, but I'm unconvinced that markets would reward such behavior, or that they should. I think that moderate inflation all of the time should be a policy goal, but that brief spikes above inflation targets should be tolerated only due to other overwhelming policy goals. Taking a gamble on debt reduction is not one of these goals. It may be a side effect, but it shouldn't be the reason for forgoing monetary tightening.

An example when inflation higher than normal may be appropriate: Stanley Fischer has had a devilish time balancing the needs of the BoI lately. The Israeli economy weathered the recession much better than the rest of the developed world (with the possible exception of Australia), and quickly resumed remarkable growth after a brief recession. This has put upward pressure on prices which would normally be counteracted with monetary tightening. Yet if rates get too high while the rest of the rich world flounders, the shekel is exposed to a huge amount of carry trade which will utterly ruin the economy (notably through suppressing exports). So, Fischer has run the ragged edge of the high end of the inflation band while implementing all sorts of unconventional policies - reporting and limits on forex transactions, sopping up huge amounts of liquidity by increasing the size of currency reserves, etc. This is all in the context of a looming housing bubble in the country due to a supply shortage and speculation, which makes it tough to pursue a too-loose monetary policy (he's counteracted this by requiring even stricter downpayments for mortgages and requiring larger reserves set aside for mortgage porfolios). It's a risky monetary policy, but its one saving grace is that it's better than all of the alternatives, and seems to have worked, more or less.

[RandBlade]

I agree with you. This was not intended to be a UK-specific discussion, that was just an example, but on that I would expect and desire the BoE to be doing what it needs to do in order to bring inflation back under control. If there was even a hint that they were not trying to then I would not like to see the consequences.

I am not suggesting that higher-than-expected inflation is something we should be looking for. I am just saying, when it happens temporarily (just here temporary has been longer than normal) its not necessarily an entirely bad thing. It shouldn't be policy by any means though.

[wiggin]

Oh, absolutely agreed. I thought you were suggesting that debt reduction through inflation was good as a matter of policy rather than happenstance. I think there are good policy reasons why spikes in inflation should be tolerated, but debt reduction isn't one of them.

[RandBlade]

No not policy. Debt reduction is a fact though and I don't see why you aren't willing to recognise it?

If inflation is higher than interest then debt is getting reduced (and non-index-linked savings are too conversely). Agreed?

[Aimless]

I sometimes muse on how wonderful Sweden would have been today if our inflation hadn't been well below 2% for over a decade

[wiggin]

No not policy. Debt reduction is a fact though and I don't see why you aren't willing to recognise it?

If inflation is higher than interest then debt is getting reduced (and non-index-linked savings are too conversely). Agreed?

No, I fully agree with you that debt reduction will happen as a matter of course if inflation is increased temporarily. If inflation expectations increase, though, then debt reduction will not occur; that's the caveat about such reduction only occurring during temporary spikes in inflation.

[RandBlade]

Indeed.

[Lewkowski]

Inflation is bad because its a hidden tax. Government creates inflation. It lowers debt (because its worth less now) and makes the people's money worth less. This is a stealth form of taxation and all taxation should be transparent.

[LittleFuzzy]

Inflation is bad because its a hidden tax. Government creates inflation. It lowers debt (because its worth less now) and makes the people's money worth less. This is a stealth form of taxation and all taxation should be transparent.

Government is not the only source of inflation. It can be created by other actors and means.

[GGT]

....

Similiarly with debt, our debt burdens can become too high. If interest can be kept lower than inflation (a big if) then it allows a reduction in the real burden of that debt. My mortgage interest rate, like government bonds, is lower than the rate of inflation. As long as it can stay that way, as a taxpayer and a homeowner I'm happy.

I don't think inflation should be allowed to run out of control. Major inflation is definitely a bad thing. However if instead of 1% or 2% its 3% or 4% its not the end of the world. It may even be a good thing.

"Inflation" affects long-term debt differently than other forms of savings and investing. Your mortgage interest was locked at low rates, because policy makers and central bankers were trying to spur economic growth in the form of more borrowing/lending. That debt favors banks and mortgage companies, in transaction fees, as well as home buyers.

But those same inflation-free rates of credit and debt also mean low (zero) rates on savings interest, 'punishing' savers. The kind of savers that would buy bank CDs, and recapitalize over-leveraged banks over time. The type of saver who can't stomach "the market" volatility chasing 5% profits, living on fixed income, but doesn't want to squirrel money under the mattress.

Some moderate "inflation" in interest rates would be better than what we have now.

[Hazir]

Government is not the only source of inflation. It can be created by other actors and means.

Unless you have QE going on on the scale we see in the western world at the moment. Otherwise you're of course right; a significant rise of the oil price could under normal circumstances easily have a bigger impact on inflation than government fueled inflation. I would go as far as saying that other actors than government typically are the main cause of inflation.

[Lebanese Dragon]

How often does infaltion increase your tax bracket, and if your still within the same tax bracket then your purchasing power and the real value of that taxation should remain the same.


Here's a crazy idea, and be nice if people could tell me why it wouldn't work:

Why doesn't our country print a ton of money, but not put into a circulation then do the following:

1.) Making multiple transaction with that money with other countries to buy lot of expensive stuff.

2.) Simultaneously, the same day we're buying the stuff, convert all our USD we have left over in banks, with the fed etc (after the Great Printing)... and exchange for multiple stable currneces of other nations. Just convert all the money we have left over after we make these huge purchases off our printed money, and get it at a value that's pre-inflationary.

I really don't know how the internation community would react, but suppose they couldn't find a good response, would this just be a ridiculous way to leach tons of resources from other nations.

[RandBlade]

Here's a crazy idea, and be nice if people could tell me why it wouldn't work:

Why doesn't our country print a ton of money, but not put into a circulation then do the following:

1.) Making multiple transaction with that money with other countries to buy lot of expensive stuff.

2.) Simultaneously, the same day we're buying the stuff, convert all our USD we have left over in banks, with the fed etc (after the Great Printing)... and exchange for multiple stable currneces of other nations. Just convert all the money we have left over after we make these huge purchases off our printed money, and get it at a value that's pre-inflationary.

I really don't know how the internation community would react, but suppose they couldn't find a good response, would this just be a ridiculous way to leach tons of resources from other nations.

You can only print your own currency though, so what would you buy from other countries with it? Lets say you wanted to buy up shares in businesses in Europe, you'd have to convert the dollars to euros/sterling before you could do that, which in such a scale would crash the system before you did number one.

[wiggin]

How often does infaltion increase your tax bracket, and if your still within the same tax bracket then your purchasing power and the real value of that taxation should remain the same.


Here's a crazy idea, and be nice if people could tell me why it wouldn't work:

Why doesn't our country print a ton of money, but not put into a circulation then do the following:

1.) Making multiple transaction with that money with other countries to buy lot of expensive stuff.

2.) Simultaneously, the same day we're buying the stuff, convert all our USD we have left over in banks, with the fed etc (after the Great Printing)... and exchange for multiple stable currneces of other nations. Just convert all the money we have left over after we make these huge purchases off our printed money, and get it at a value that's pre-inflationary.

I really don't know how the internation community would react, but suppose they couldn't find a good response, would this just be a ridiculous way to leach tons of resources from other nations.

Just how much money do you actually think is printed anyways? Most of our money supply is virtual.

[Lebanese Dragon]

Just how much money do you actually think is printed anyways? Most of our money supply is virtual.

You can only print your own currency though, so what would you buy from other countries with it? Lets say you wanted to buy up shares in businesses in Europe, you'd have to convert the dollars to euros/sterling before you could do that, which in such a scale would crash the system before you did number one.

If the computer wouldn't crash would it work or are there still other countermeasures? What would you postulate the intenational reaction to be. Not trade with America, or Devalue their own currency, switch currencies.

[Lewkowski]

Government is not the only source of inflation. It can be created by other actors and means.

Sure however *most* inflation occurs due to government.

[RandBlade]

Sure however *most* inflation occurs due to government.

I would go as far as saying that other actors than government typically are the main cause of inflation.

[agamemnus]

Fight, fight!

[earthJoker]

I don't think you can make a general statement either way. It really depends on how much the national bank is (in)dependent of the government and what policies it has.

[RandBlade]

I don't think you can make a general statement either way. It really depends on how much the national bank is (in)dependent of the government and what policies it has.

Not so sure I 100% agree. I'm honestly not certain which if either has a dominant effect, but I do think one of the biggest effects in recent decades is state of the global economy.

The rise of China etc, just as much as the actions of Central Banks, has kept interest rates low.

[LittleFuzzy]

Not so sure I 100% agree. I'm honestly not certain which if either has a dominant effect, but I do think one of the biggest effects in recent decades is state of the global economy.

The rise of China etc, just as much as the actions of Central Banks, has kept interest rates low.

But that sort of effect from other governments is not what Lewk meant either. I stand by my wording which makes no conclusive or exclusive statements. Now if Lewk wants to dial down and explicitly say what I'm pretty sure he was thinking I'd be willing to provide a more ringing denial of his claim.

[Lewkowski]

But that sort of effect from other governments is not what Lewk meant either. I stand by my wording which makes no conclusive or exclusive statements. Now if Lewk wants to dial down and explicitly say what I'm pretty sure he was thinking I'd be willing to provide a more ringing denial of his claim.

I think its obvious I'm talking about the action of American government on American currency. Sure economic factors can cause inflation/deflation (ie spikes in oil can have a cascading effect) and other countries manipulation of their currency can have an impact on our currency. Bottom line however is that I believe the majority of inflation of American current is caused by our government.

[Aimless]

A quick question for the brain trust re. making money: who makes money anyway? I thought huge investment banks made money (from promises hopes and dreams ) and now you guys are saying it's the government. Isn't the government's role mostly indirect, in most of the west??

[RandBlade]

Depends what you mean by making money. The government literally prints it, but as already explained most money in circulation is not printed

[Aimless]

Depends what you mean by making money. The government literally prints it, but as already explained most money in circulation is not printed

Does that mean that most money is in fact made by eg. banks? Would that mean that banks are the most proximal driver of inflation?

[RandBlade]

I would be wary of naming any individual organisation as mainly responsible.

[LittleFuzzy]

Does that mean that most money is in fact made by eg. banks? Would that mean that banks are the most proximal driver of inflation?

As Rand says, it would be. . .awkward. . . to try and put the blame on banks. Because of course another way of looking at it is that the general increase in value of a growing market is the proximal driver and money is merely measuring that increase. The inflation term is used very broadly and in many cases is more of a term for the models than the reality. It's an abstraction and generalization of multiple processes, each of which demonstrates different behaviors and values in different countries, regions, governments, or seasons.