Rajan on Why the Inflation Solution is Not a Solution at All

|Peter Boettke|

Very brilliant economists, such as Ken Rogoff, have argued that the way out of current situation is to have a decade of 4-6% inflation.  Personally, I have been in shock that this approach has been advocated in such a cavalier manner.  To me this is the ultimate form of embracing the "holding the tiger by the tail" and I am not sure how it squares with even weak rational expectations assumptions.   But if someone as bright as Ken Rogoff, who thinks seriously about macroeconomic issues, holds this position, perhaps it demands more attention.  In addition, my colleagues at GMU who I respect greatly, such as Tyler and Bryan, have said similar things about the monetary policy response to our situation.

In the end, I still don't believe this solution is a solution, and instead would sink the economy into an even worse situation.  This is why the analysis of Raghuram Rajan seems to me to be more accurate.

What do you think?

 

HT: Chris Coyne

Comments

[Jerry O'Driscoll]

Rogoff's position is the height of hubris, and not even consistent with his own research. The idea that monetary authorities can engineer a "moderate" inflation and than control it within a narrow band is absurd (as Larry Summers, among others, has pointed out).

As Rogoff has shown, in the aftermath of a debt and banking crisis, transactors desire to save more. Destroying their wealth and savings impoverishes them. How is that a cure?

Nonetheless, I am assured that Rogoff's plan is being officially encouraged. It is the administration's desired outcome. Will the ever pliant Chairman Bernanke deliver?

The next shoe to fall will likely be sovereign debt defaults in the EU. They will reveal that the EU banks are insolvent. US prime money market funds have almost 50% of their assets invested in EU banking organizations,

Inflation will then be all but inevitable, and it will be global. To work its magic, inflation will need to increase well beyond 4-6% annual rates. Of course, governments always fall in such inflationary episodes.

Holding a Tiger by the Tail is the right analogy.

[KipEsquire]

My view on this is strictly positive, not at all normative: "inflation for a generation" (note: not a decade) WILL be the solution. Not because it's a good idea, but because it's the only politically feasible idea.

These guys can't even scrap ethanol. Who really thinks they're going to fix entitlements? It's laughable.

[Bill Woolseu]

I have two positive things to say about inflation under current conditions. Many long term debts were contracted under a 2% inflation regime. It would take approximately 5% inflation over the next year to return the price level to the growth path of the Great Moderation.

I don't favor inflation targeting, but rather nominal GDP targeting. During the Great Moderation, nominal GDP was on an approximate 5% growth path. While I prefer a 3% growth path, I think keeping to that 5% growth path would have been sensible.

I believe that the productive capacity of the economy has been depressed by the need to reallocate resources. How much? I don't know. But the CBO makes some estimates, and that is what generates the official output gap. According to CBO, potential output is well below its trend of the Great Moderation.

With nominal GDP targeting, slow growth of potential output results in a higher price level and so inflation. Rather than the 2% trend inflation, during the last 5 years, there would have been many quarters of 3% inflation and a good number with 4% inflation. Again, assuming nominal GDP grew 5% and potential output grew at the slow rate estimated by the CBO.

Anyway, in order for the price level to get to the level it would be at if nominal GDP were on its trend growth path and potential output were at the level estimated by the CBO within a year, the inflation rate would need to be 12%.

Rather than a year of 5% inflation, something like three years of 5% inflation would result in a price level close to what I would have thought least bad.

I would have looked at nominal GDP over the last 5 years, and each quarter, when inflation came in at 3%, or even 4%, and real output growth was at 2% or even 1%, I would have said that this is the least bad option. I would not have advocated restricting money growth so that nominal GDP growth slowed, to get inflation down.

Selgin has run through the arguments as to why this is not unjust to creditors. If there is a productivity slowdown, creditors should share in the loss. More or less.

My view is a little different. If people do straight nominal contracting, this is a good baseline. (Creditors share in the losses and gains of unanticipated productivity shocks.) And if they want to do indexing to the price level, then fine.

Shifting to a new regime (from 2% inflation to 5% nominal GDP growth) is a bit different.

The Fed, of course, didn't really have a target for the growth path of the price level. It was an inflation target, and "supply shocks" would have resulted in a higher price level (somewhat like what would happen with nominal GDP targetting.)

And, of course, what are the implications of a failure by the Fed to keep an excess demand for money from reducing money expenditures on output under this regime? What we got?

Still, imagining that we were in an equilibrium with a stable price level, and that we are considering the impact of an unanticipated inflation like a bolt from the blue, is hardly appropriate either.

[Jim Rose]

It is one of the prices of the Fed not having a formal inflation target.

adopting an inflation taget implicitly gives up on trying to stablise output and unemployment as a policy goal.

[Mario Rizzo]

Targets are as useful (*when they are useful*) as the credibility of the institution announcing the target. How credible is the Fed?

[david nh]

" But if someone as bright as Ken Rogoff, who thinks seriously about macroeconomic issues, holds this position, perhaps it demands more attention."

Some errors, as they say, require a high IQ.