EconoMonitor

Conditional Inflation Now!

Back in January, Jeffry Frieden and I argued for higher inflation, conditioned on macro conditions, in a Foreign Policy article. The roster of economists in favor expands: Nobel laureates Rob Engle and Paul Krugman join Chicago Fed President Charles Evans, for the US.

Regarding the eurozone, the Economist has argued that Germany must reflate. Simon Wren Lewis provides another argument for a looser monetary policy based on (what I take is) a credit-based model of income determination (undergraduate level algebra here).

From Whip Up Inflation Now:

[We need] inflation — just enough to reduce the debt burden to more manageable levels, which probably means in the 4 to 6 percent range for several years. The Fed could accomplish this by adopting a flexible inflation target, one pegged to the rate of unemployment. Chicago Fed President Charles Evans has proposed something very similar, a policy that would keep the Fed funds rate near zero and supplemented with other quantitative measures as long as unemployment remained above 7 percent or inflation stayed below 3 percent. Making the unemployment target explicit would also serve to constrain inflationary expectations: As the unemployment rate fell, the inflation target would fall with it.

We believe that now is the time to act, as the US recovery sputters along, and the austerity-based approach in the Eurozone shows a need for revision. Higher inflation would serve to erode real debt, both private and public; it would also ease the adjustment of relative prices and wages, as an alternative to internal devaluation via nominal price/wage changes. Both US and eurozone inflation rates are relatively low right now.

condinflnow1.gif
Figure 1: Twelve month inflation rates for US Personal Consumption Expenditure deflator (blue), and for Eurozone Harmonized CPI (red). Source: BLS via St. Louis Fed FRED, and ECB.

Furthermore, we can act because inflationary expectations are anchored at low rates. Two year ahead inflationary expectations expectations for the US and the eurozone are both low.

condinflnow2.gif
Figure 2: Survey based expectations for PCE inflation over the next two years (blue), and for eurozone HCPI inflation (red). Source: Philadelphia Fed Survey of Professional Forecasters median, and February ECB Survey of Professional Forecasters, both February 2012.

Now, as Jim has pointed out, merely raising a target inflation rate (or declaring a nominal GDP target) does not mean that the mechanics are straightforward. But my personal view is that, the costs of enduring years of high unemployment is too high, relative to the costs of exceeding target inflation, especially if it is made clear that the target increase is conditional on the state of the economy.

This post originally appeared at Econbrowser and is posted with permission.

3 Responses to “Conditional Inflation Now!”

John CardilloMay 8th, 2012 at 11:35 am

I agree, we need inflation. The trick is to channel inflation into wage increases accross all sectors of the economy. Attempts to ease monetary policy seem to be relentlessly hijacked by wallstreet speculation on oil and other commodities. So for most, unless you work in the oil industry, inflation doesn't help like it used to..

William HalversonMay 9th, 2012 at 9:25 am

"We need inflation"? Who is we? The banksters? Only bankers and politicians like inflation. Anyone living moderately within his means abhors inflation. "Channeling inflation into wage increases" is impossible. It sounds like you have been living on planet finance too long.

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