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Home Publications Blogs Beat the Press Robert Samuelson Gets Serious About Inflation

Robert Samuelson Gets Serious About Inflation

Monday, 07 May 2012 04:52

Robert Samuelson had a serious discussion of Paul Krugman's idea (and in his professor days, Ben Bernanke's) that the Fed could boost demand by deliberately targeting a higher rate of inflation. The idea is that this would lead to a lower real interest rate.

If businesses expected inflation to be 4.0 percent over the next five years, rather than 2.0 percent, it would give them more incentive to invest. They would be able to sell everything for 20 percent more money in five years. Higher inflation would also erode the debt burden of homeowners and others with large debts. This could free up additional money for consumption. 

While Samuelson acknowledges the potential benefits from higher inflation in boosting growth he still opposes the policy. He cites Bernanke's own objection as Fed chair, that it could undermine the inflation-fighting credibility of the Fed in the future. He also adds his own objections:

1) wages might not keep pace with inflation, dampening purchasing power;

2) higher inflation may lead consumers to become fearful and therefore save rather than consume;

3) financial markets might over-react and demand higher real interest rates.

There is some validity to each of these, but it is likely that the negative effects would be dwarfed by the potential gains in a context of continued high unemployment. In the case of the Fed's inflation fighting credibility, that might be nice, but we are losing over $1 trillion in output a year because of the continuing downturn. Millions of unemployed workers and their families are seeing their lives ruined. It is hard to imagine a loss of Fed credibility that can be remotely equal in cost.

As far as wages keeping up with inflation, we have a long history on this. In general they do, there is not a negative relationship between real wages and inflation. Of course, everyone's wages will not keep pace with inflation. They will be losers in this story. But anyone who thinks they have a policy that will lead to large gains without hurting anyone has not studied their policy closely enough. (Many of the workers who would see real wage cuts with higher inflation would have lost their jobs if inflation had remained lower.)

Samuelson's argument that consumers will become fearful seems unlikely in an environment of 4-5 percent inflation. This could happen if we see the sort of double-digit inflation that we saw in the 70s. Although even then consumers were not that fearful -- economists like Martin Feldstein were still complaining about insufficient savings.

The same argument applies to the point about the interest rates demanded by investors, with the additional provision that the Fed can insure a supply of low interest loans to potential investors through its zero interest federal funds rate and its quantitative easing policies. While this may imply some greater risk premium associated with loans at some point in the future, that would again seem a minor concern in the current context.

Anyhow, it is refreshing to see Samuelson trying to engage seriously on this topic and to put his concerns on the table. I think he is mistaken, but this is the debate that we should be having.

Comments (11)Add Comment
Good step toward real debate
written by Robert Salzberg, May 07, 2012 7:35
Bernanke's position is nothing if not predictable, as it should be. Which brings us to the real question, why aren't governments treating the unemployment rates as a crisis?

Governments have lots of levers to pull when it comes to employment and lack of demand. Hopefully, the results of the elections in Europe will push governments around the world to finally see that austerity in a depressed economy is cruel and stupid policy.
The return of the queen
written by David, May 07, 2012 7:53
Rationality returns, perhaps? Samuelson now just needs to learn what "the greatest generation" learned: courage is the decision to act for the greater good, despite one's fears. We need heroes, not frat boys shivering in the trenches. Lack of action is also an action; would Samuelson just let his countrymen be shot down in droves? Risk aversion is natural. Inaction is often the smart thing to do. But this is not the time.
On wages keeping up with inflation...
written by Bill H, May 07, 2012 10:34
"As far as wages keeping up with inflation, we have a long history on this."

Do we have a history of wages keeping up with inflation during a "jobless recovery" and high unemployment? I think not. I question the claim to begin with, because with 50 years of working for hourly wages my experience is contrary to that and in any case given the current conditions I am all but certain that wages will not increase with inflation. History only repeats when conditions repeat, and not always then.
Investment is not the basic economic objective.
written by Ralph Musgrave, May 07, 2012 11:20

Dean Baker’s argument is flawed.

First, given the need for more demand, why on earth raise just INVESTMENT spending (rather than spending on ice cream, cars or massage parlours)? In other words if more demand is needed then raise public spending and/or cut taxes so that households spend more. What’s the basic purpose of the economy: to invest or to provide what the consumer wants?

Second, I am sceptical that “Higher inflation would also erode the debt burden of homeowners….”. Nominal interest rates would immediately rise to compensate for the inflation (as they did in the 1970s). So those taking out new mortgages or re-financing would be hit. Plus if it becomes generally accepted that government wipes out a portion of household debt every time households become too indebted, then lenders will just charge more to compensate for this over the next few decades.

so dumb
written by Peter K., May 07, 2012 11:57
Classically wrong article on French elections in the Times business section. I could have written it.


Also Musgrave is wrong in multiple ways. You monetary mystics/MMTers keep at it though, maybe you'll convince somebody somewhere. Not me though.
well ok but how does that work exactly?
written by dwb, May 07, 2012 1:21
we should be deeply skeptical about the ability for firms to raise prices in the face of 8.2% unemployment. Recall that they tried this last year and had to take it back.

Think about the bigger picture, personal income is 85% of GDP. So how does a higher inflation deflator flow? most of it flows to wages, compensation, and transfer payments. So seems to me *demand side* inflation is pushing incomes up and accellerating mortgage equity withdrawl (which is 2.2% of personal disposable income).

if commodities prices are going up, wages are flat, prices are flat, corporate profits are squeezed.

Which gives you an idea why and who is opposed to a higher inflation target.

Now, as Hamilton points out, the Fed has invested a lot of capital in the 2% PCE target and the Fed's credibility is a huge asset.

However, I would argue that the Fed has invested credibility in the wrong thing since its a dual mandate central bank.

The real issue before the Fed is how to make the output gap/inflation tradeoff, how to quantify it.

What I would like to see is the Fed start by essentially saying, "we will tolerate x% higher inflation if and only if output is x% lower than potential." now, there may or may not be more inflation (in fact, I think its more likely to be real growth which is better).

This is essentially the balanced taylor rule Bernanke told us about in jan 2012 and jan 2010. From there its a small step to ngdp targeting.

thats what the fed should be investing its credibility in!
Inflation leads to more spending
written by Tony K, May 07, 2012 2:08
In my experience, having lived in Argentina during high inflation, people tend to spend more when the value of their cash is eroding. Putting it under a mattress or in a lower returning vehicle is a sure path to value destruction for individuals.
real wages lag productivity...thats the problem...
written by pete, May 07, 2012 3:50
Yes, the charts a few weeks ago showed that real wages were kind constant...But mean while corporate profits and salaried employees undoubtedly saw gains. Hence the redistribution from the poor to the middle class and above during inflations. Keynes was not a socialist. Dean, you point out more employment, yes indeedy, but at lower wages in the short run, and productivity gains going to others. The behavioral quirk of monetary illusion, which is a framing problem, can certainly be used by the technocrats in D.C., but it is going to worsen equality, as it has since the early 70s when the inflation rate doubled over its post war rate. 1968 was peak income equality.
My experience with inflation
written by parsec, May 07, 2012 4:02
Working at modest wages in the 70s and 80s I discovered that my pay did keep pace with inflation pretty well during this period. The hourly rate went up without my having to ask for raises as a part of some automatic adjustment mechanism which I don't understand to this day. As for investing, I discovered that short-term Treasuries kept pace with inflation pretty well. The yield topped out around 15% for a brief period.
Musgrave wrong in so many ways?
written by Ralph Musgrave, May 08, 2012 3:07

Peter K, You say I am “wrong in so many ways”. But you fail to specify a single way in which I am wrong. I’ll conclude for the moment that you can’t think of any way in which I am wrong.
written by Nathanael, May 12, 2012 6:44
Regarding "wages keeping up with inflation"... give workers more pricing power by employing a lot more people (perhaps with a Civilian Conservation Corps or something) and you can get nice solid wage inflation. Which is what we want, right? Why use price-driven inflation when you can use wage-driven inflation?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.