Monday, 2 November 2015

Krugman says raise inflation.

I normally agree with Krugman, but not with this article. He’s joined the chorus of voices pushing for a higher inflation target, the idea being that come the next recession, central banks have more room for manoeuvre. That is, given inflation of say 4% instead of 2%, and assuming a central bank cuts interest rates to say 1%, that means  the real rate of interest is minus 3% instead of minus 1%.  And that minus 3% real rate supposedly gives the economy more of a boost than the minus 1% real rate .

But how do we actually get inflation up to 4%? Well Robert Mugabe knows how to do that, though half the world’s so called “professional” economists seem to think that raising inflation is difficult. The answer is a nice big dose of fiscal stimulus, perhaps assisted by QE. And those two in combination come to the same thing as “the state prints money and spends it, and/ or cuts taxes”.

But hang on: the BASIC object of the exercise is to get the economy up to the capacity or “full employment” level. Once you’ve done that, it’s a case of “problem solved”.

What then is the point of boosting demand even more (which may bring no additional real output) with a view to boosting inflation from 2% up to 4%?

Put another way, what’s the point of giving the economy EXCESS stimulus via fiscal means, and then partially negating that with raised interest rates? As I pointed out here, that’s very similar to controlling a car’s speed by having  the accelerator permanently on the floor, and controlling the speed by apply varying amounts of pressure to the brake pedal.

The only excuse for that “accelerator and brake” policy would be if interest rate adjustments worked quicker and more predictably that fiscal stimulus. But there seems little evidence to support that.

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