Could Inflation Bring Back the Economy?

Maybe all consumers need is a little prodding

This article is from the archive of our partner .

Would inflating the currency boost spending and help to revive the economy? In the past week, economists and econobloggers have been debating this idea. Increasing the money supply might act as a powerful stimulus, but given the current political climate and a meek Fed, is such a measure even possible? Economics writers are also weighing the risks and undesirable side effects of deliberate inflation.

  • The Case for Inflation  The Fed "has a number of tools at its disposal," explains economist Tyler Cowen in The New York Times, "but if it could just convince Americans that it was committed to monetary expansion and economic growth, it would help the economy pick up speed." It has tried "supplying more money," but that didn't "result in enough additional spending" because current instability means people are holding onto the money and saving it, instead of spending. So here's Cowen's proposal: "If the Fed promises to keep increasing the money supply until prices rise by, say, 3 percent a year, people should eventually start spending. Otherwise, if they just held the money, it would be worth 3 percent less each year." Of course, he's not sure this is possible. "Older people, creditors and workers on fixed incomes--all connected to powerful lobbies--would start to complain," and "the Fed is not receiving enough signals of support from Congress."
  • How It Would Help  There are two current problems, explains The New Yorker's James Surowiecki. "First, consumers face huge debt left over from the borrowing spree of the past decade. Second, the dominant sentiment is caution--consumers are hesitant to spend, and businesses are hesitant to expand, invest, and hire." Inflation could address both, as Neil Irwin explains in greater depth at The Washington Post. "Inflation would make the heavy debt that Americans carry a bit more manageable as wages rise but the amount owed stays the same. And it would create more incentive for businesses to invest their cash rather than sit on it, because inflation would reduce the value of hoarded money." Unfortunately, as Surowiecki notes, "people loathe inflation even in moderate doses."
  • The Fed Shouldn't Promise to Inflate Unless It Can Deliver, says Reuters's Felix Salmon, responding to Cowen's proposal. And if it can deliver, then why bother promising?
My feeling about an inflation target is that its mere existence is not going to convince anybody that inflation is on the way. So unless and until the Fed can credibly explain how it’s going to create 3% inflation, it shouldn't even think about unveiling a target. And if it can credibly explain how it's going to create 3% inflation, then it doesn't need the target at all.
  • Doing This Would Be a Big Risk for the Fed  The institution's credibility is currently low, writes The Economist's Ryan Avent. "The Fed can buy credibility and with it an end to disinflation and much of the pain of the slow recovery. But doing so would put the Fed on the hook in the event that policy fails."
  • And Would Inflation Even Be that Great?  "There's a great temptation in policy circles to think that whenever you are plagued by a given problem, its exact opposite would be much more desirable," writes The Atlantic's Megan McArdle, who also notes that "targeting is never that exact," and aiming for 3% inflation could result in levels higher than that. 
And there would be problems.  Interest rates might well overshoot, particularly on long-term debt like mortgages, putting a crimp in the housing market and other asset markets where debt finance is important.  Senior citizens would be very unhappy, and might well put a greater strain on the public purse.  Tax brackets would creep even faster unless congress was vigilant.  In that situation, we might well have a bunch of pundits asking, "Wouldn't it be great if inflation were lower?"
This article is from the archive of our partner The Wire.