Conditional Inflation Now

Menzie Chinn and Jeffrey Frieden, authors of Lost Decades: The Making of America’s Debt Crisis and the Long Recovery, have a piece up at Foreign Policy calling for the Federal Reserve to clearly indicate willingness to tolerate a period of elevated inflation as a key measure that could boost economic growth. Chicago Federal Reserve President Charles Evans’ proposal along these lines is not the most theoretically elegant monetary policy idea, but it has the advantage of being relatively easy to understand and as well as an influential advocate. Chinn and Frieden name-check Evans, and focus on the extent to which his ideas could help speed a debt-deleveraging cycle but it’s also possible to think of it as simply boosting recovery processes that are already underway.

Imagine a less moderate version of Evans’ proposal in which the Federal Reserve says it would welcome inflation in the four to six percent range at least until the unemployment rate falls below six percent.

One very important thing this does is reassure optimists. I think we’re positioned for a measure of recovery this year as new housing starts rise and orders for automobiles and other durable goods go up, pushing incomes up. But I do worry that if this happens, we’ll see an increase in rents and depending on the international situation possibly also gasoline and food prices, and I worry that if that happens pressure will exist to nip the recovery in the bud. So I have an optimistic analysis of the basic situation, but I’d still be hesitant to wager a large sum of money on the strong recovery happening because I worry that policy error might undermine it. Pre-commitment to tolerating inflation boosts the spirits of optimists, encouraging the formation of pro-growth patterns of expectations and investment.

But an equally important thing a strong conditional statement would do is scare pessimists. If you watch daytime cable news or listen to Ron Paul, you’ll see there are already plenty of people out there primed to worry about inflation. A clear statement that the Federal Reserve is prepping to become even laxer with the money drives that fear forward. And if you think medium-term inflation is going to rise, then suddenly it makes less sense to park your funds in low-yield high-liquidity instruments. It becomes more attractive to either secure riskier, higher-yielding financial assets or else just go out and buy stuff. The Fed can inflate the value of your money away, but they can’t take your car or your washing machine or your house.

So optimists and pessimists would have a different take on the real meaning of this idea, but the basic upshot is the same—Americans who aren’t burdened by excessive debt or bad credit ought to go buy cars and washing machines and houses or else ought to go out and invest in the production of cars and washing machines and houses. Either way, these are actions that, completely apart from the impact of inflation on debt burdens, will raise incomes across the board and end up helping the over-leveraged. It’s not some magic cure-all to every problem afflicting America, but would provide a tremendous boost to the specific problem of being simultaneously saddled with millions of unemployed people and a rapidly aging stock of housing and durable goods.