Thursday, 22 September 2016

Apparently inflation is now a fundamental economic objective. Mad or what?

Many economists – those people who allegedly know all about economics – currently seem to argue that raising inflation is an end in itself. This Bloomberg article is a typical example.

The first paragraph reads “Japan’s central bank has long been battling an ailment that now afflicts much of the developed world: unduly low inflation, which tends to go together with lackluster economic growth. If it wants to succeed in its efforts, it may have to aim to overshoot its inflation goal.”

Well the “tends to go together with” point is true in that given a rise in demand we tend to get a rise in numbers employed (desirable) and a rise in inflation (not at all desirable in itself).

However the consensus is that inflation of up to about 2% is a price worth paying for getting numbers employed as high as possible. (I’ll assume no Job Guarantee so as to keep things simple).

The author (an economics prof) then says “The lack of success might stem from an inadequately ambitious strategy. One key to achieving higher inflation is convincing people and companies that prices will start rising faster.”

Now hang on. If employers raise their prices and unions raise wage demands SIMPLY BECAUSE they think inflation will rise, that does not of itself raise demand. So we get the DISADVANTAGE of inflation (i.e. inflation itself, so to speak) without the attendant advantage, i.e. increased numbers employed!

A possible escape from that nonsense is to argue that given higher inflation, households and firms will try to spend away their stock of money since no one wants to be in possession of an asset that is declining in value, and that “spending away” will raise demand (sometimes known as the “hot potato effect”). But the author of the article says nothing about that.

Moreover, it’s equally possible that people react to a decline in the value of money by trying to save and stock up on MORE of the stuff because they’re aiming to have some given stock of money in REAL TERMS.

So which of the two latter effects predominates? That question is crucial. If the second effect predominates then the entire “artificially raised inflation gets us out of recessions” argument collapses.

So does the author cite any evidence on the latter crucial question? Nope!

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