Inflationism

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Inflationism is a heterodox economic, fiscal, or monetary policy, that predicts that a substantial level of inflation is harmless, desirable or even advantageous. Similarly, inflationist economists advocate for an inflationist policy.

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Mainstream economics holds that inflation is a necessary evil, and advocates a low, stable level of inflation, and thus is largely opposed to inflationist policies – some inflation is necessary, but inflation beyond a low level is not desirable. However, deflation is often seen as a worse or equal danger, particularly within Keynesian economics, as well as Monetarist economics and in the theory of debt deflation.

Inflationism is not accepted within the economics community, and is often conflated with Modern Monetary Theory, which uses similar arguments, especially in relation to chartalism.

Political debate

An 1896 cartoon showing a Free Silver farmer and a Democratic donkey whose wagon has been destroyed by the locomotive of sound money. 96SILVER.JPG
An 1896 cartoon showing a Free Silver farmer and a Democratic donkey whose wagon has been destroyed by the locomotive of sound money.

In political debate, inflationism is opposed to hard currency, which believes that the real value of currency should be maintained.

In late 19th century United States, the Free Silver movement advocated the inflationary policy of free coinage of silver. This was a contentious political issue in the 40-year period 1873–1913, consistently defeated. Later, economist John Maynard Keynes described the effects of inflationism:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. [1]

Schools of economic thought

Inflationism is most associated with, and a charge most leveled against, schools of economic thought which advocate government action, either fiscal policy or monetary policy, to achieve full employment. Such schools often have heterodox views on monetary economics

The early 19th century Birmingham School of economics, which advocated expansionary monetary policy to achieve full employment, was attacked as "crude inflationists".

The contemporary Post-Keynesian monetary economic school of Neo-Chartalism, which advocates government deficit spending to yield full employment, is attacked as inflationist, with critics arguing that such deficit spending inevitably leads to hyperinflation. Neo-Chartalists reject this charge, such as in the title of the Neo-Chartalist organization the Center for Full Employment and Price Stability.

Neoclassical economics has often argued a deflationist policy; during the Great Depression, many mainstream economists argued that nominal wages should fall, as they had in 19th century economic crises, thus returning prices and employment to equilibrium. This was opposed by Keynesian economics, which argued that a general cut in wages reduced demand, worsening the crisis, without improving employment.

Contemporary advocacy

While few, if any, economists argue that inflation is a good thing in itself, some argue for a generally higher level of inflation, either in general or in the context of economic crises, and deflation is widely agreed to be very harmful.

Three contemporary arguments for higher inflation, the first two from the mainstream school of Keynesian economics and advocated by prominent economists, [2] the latter from the heterodox school of Post-Keynesian economics, are:

Added flexibility in monetary policy

A high inflation rate with a low nominal interest rate result in a negative real interest rate; for example, a nominal interest rate of 1% and an inflation rate of 4% yields a real interest rate of (approximately) [note 1] −3%. As lower (real) interest rates are associated with stimulating the economy under monetary policy, the higher inflation is, the more flexibility a central bank has in setting (nominal) interest rates while still keeping them nonnegative; negative (nominal) interest rates are considered unconventional monetary policy and have very rarely been practiced.

Olivier Blanchard, chief economist of the International Monetary Fund, argues that the inflation rates during The Great Moderation were too low, causing constraints in the late-2000s recession, and that central banks should consider a target inflation rate of 4% instead of 2%. [2] [3] [4]

Wage stickiness

Inflation decreases the real value of wages, in the absence of corresponding wage rises. In the theory of wage stickiness, a cause of unemployment in recessions and depressions is the failure of workers to take pay cuts, to decrease real labor costs. It is observed that wages are nominally sticky downwards, even in the long term (it is difficult to reduce nominal pay rates), and thus that inflation provides useful erosion of real costs wages without requiring nominal wage cuts. [2] [5]

Collective bargaining in the Netherlands and Japan has at times yielded nominal wage cuts, in the belief that high real labor costs were causing unemployment.

Decreasing real burden of debt

In the theory of debt-deflation, a key cause of economic crises is a high level of debt, and a key cause of recovery from crises is when this debt level has decreased. Other than repayment (paying down debt) and default (not paying it), a key mechanism of debt reduction is inflation – because debts are general in nominal terms, inflation reduces the real level of debt. This effect is more pronounced the higher the debt level. For example, if the debt to GDP ratio of a country is 300% and it experiences one year of 10% inflation, the debt level will be reduced by approximately to 270%. By contrast, if the debt to GDP ratio is 20%, then one year of 10% inflation will reduce the debt level by 2%, to 18%. Thus several years of sustained high inflation significantly reduce a high level of initial debt. This is argued by Steve Keen, among others.

In this context, the direct result of inflation is a transfer of wealth from creditors to debtors – the creditors receive less in real terms than they would have before, while the debtors pay less, assuming that the debts would in fact have been repaid, and not defaulted on. Formally, this is a de facto debt restructuring, with reduction of the real value of principal, and may benefit creditors if it results in the debts being serviced (paid in part), rather than defaulted on.

A related argument is by Chartalists, who argue that nations who issue debt denominated in their own fiat currency need never default, because they can print money to pay off the debt. Chartalists note, however, that printing money without matching it with taxation (to recover money and prevent the money supply from growing) can result in inflation if pursued beyond the point of full employment, and Chartalists generally do not argue for inflation.

See also

Notes

  1. ↑ Properly, the real interest rate in this case is but the linear approximation is widely used; see Fisher equation for details.

Related Research Articles

Keynesian economics are the various macroeconomic theories and models of how aggregate demand strongly influences economic output and inflation. In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy. It is influenced by a host of factors that sometimes behave erratically and impact production, employment, and inflation.

<span class="mw-page-title-main">Macroeconomics</span> Study of an economy as a whole

Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes national, regional, and global economies. Macroeconomists study topics such as output/GDP and national income, unemployment, price indices and inflation, consumption, saving, investment, energy, international trade, and international finance.

In economics, stagflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high. Stagflation, once thought impossible, poses a dilemma for economic policy, as measures to reduce inflation may exacerbate unemployment.

<span class="mw-page-title-main">Inflation</span> Devaluation of currency over a period of time

In economics, inflation is a general increase in the prices of goods and services in an economy. This is usually measured using the consumer price index (CPI). When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. The opposite of CPI inflation is deflation, a decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index. As prices faced by households do not all increase at the same rate, the consumer price index (CPI) is often used for this purpose.

In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%. Inflation reduces the value of currency over time, but deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slowdown in the inflation rate; i.e., when inflation declines to a lower rate but is still positive.

New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics.

<span class="mw-page-title-main">Fiscal policy</span> Use of government revenue collection and expenditure to influence a countrys economy

In economics and political science, fiscal policy is the use of government revenue collection and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variables developed in reaction to the Great Depression of the 1930s, when the previous laissez-faire approach to economic management became unworkable. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics theorised that government changes in the levels of taxation and government spending influence aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives. The combination of these policies enables these authorities to target inflation and to increase employment. In modern economies, inflation is conventionally considered "healthy" in the range of 2%–3%. Additionally, it is designed to try to keep GDP growth at 2%–3% and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilise the economy over the course of the business cycle.

Business cycles are intervals of general expansion followed by recession in economic performance. The changes in economic activity that characterize business cycles have important implications for the welfare of the general population, government institutions, and private sector firms.

<span class="mw-page-title-main">Deficit spending</span> Spending in excess of revenue

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<span class="mw-page-title-main">Causes of the Great Depression</span> Overview of the causes of the Great Depression

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Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages, and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption. Neutrality of money is an important idea in classical economics and is related to the classical dichotomy. It implies that the central bank does not affect the real economy by creating money. Instead, any increase in the supply of money would be offset by a proportional rise in prices and wages. This assumption underlies some mainstream macroeconomic models. Others like monetarism view money as being neutral only in the long run.

In economics, the Pigou effect is the stimulation of output and employment caused by increasing consumption due to a rise in real balances of wealth, particularly during deflation. The term was named after Arthur Cecil Pigou by Don Patinkin in 1948.

The real economy concerns the production, purchase and flow of goods and services within an economy. It is contrasted with the financial economy, which concerns the aspects of the economy that deal purely in transactions of money and other financial assets, which represent ownership or claims to ownership of real sector goods and services.

Modern monetary theory or modern money theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. According to MMT, governments do not need to worry about accumulating debt since they can pay interest by printing money. MMT argues that the primary risk once the economy reaches full employment is inflation, which acts as the only constraint on spending. MMT also argues that inflation can be controlled by increasing taxes on everyone, to reduce the spending capacity of the private sector.

Monetary inflation is a sustained increase in the money supply of a country. Depending on many factors, especially public expectations, the fundamental state and development of the economy, and the transmission mechanism, it is likely to result in price inflation, which is usually just called "inflation", which is a rise in the general level of prices of goods and services.

The neoclassical synthesis (NCS), or neoclassical–Keynesian synthesis is an academic movement and paradigm in economics that worked towards reconciling the macroeconomic thought of John Maynard Keynes in his book The General Theory of Employment, Interest and Money (1936) with neoclassical economics.

Debt deflation is a theory that recessions and depressions are due to the overall level of debt rising in real value because of deflation, causing people to default on their consumer loans and mortgages. Bank assets fall because of the defaults and because the value of their collateral falls, leading to a surge in bank insolvencies, a reduction in lending and by extension, a reduction in spending.

<span class="mw-page-title-main">History of macroeconomic thought</span>

Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.

In macroeconomics, chartalism is a heterodox theory of money that argues that money originated historically with states' attempts to direct economic activity rather than as a spontaneous solution to the problems with barter or as a means with which to tokenize debt, and that fiat currency has value in exchange because of sovereign power to levy taxes on economic activity payable in the currency they issue.

In economics, non-accelerating inflation buffer employment ratio (NAIBER) refers to a systemic proposal for an in-built inflation control mechanism devised by economists Bill Mitchell and Warren Mosler, and advocated by Modern Money Theory as replacement for NAIRU. The concept of NAIBER is related to the idea of a job guarantee aimed to create full employment and price stability, by having the state promise to hire unemployed workers as an employer of last resort (ELR).

References

  1. ↑ John Maynard Keynes, The Economic Consequences of the Peace, 1919. pp. 235–248. PBS.org – Keynes on Inflation
  2. 1 2 3 Krugman, Paul (February 13, 2010), "The Case For Higher Inflation", The New York Times
  3. ↑ Interview with Olivier Blanchard: IMF Explores Contours of Future Macroeconomic Policy, by Jeremy Clift, IMF Survey online, February 12, 2010
  4. ↑ Rethinking Macroeconomic Policy, IMF, February 12, 2010
  5. ↑ Near-Rational Wage and Price Setting and the Optimal Rates of Inflation and Unemployment, George A. Akerlof, William T. Dickens, and George L. Perry, May 15, 2000
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