Thursday, May 2, 2013

Paul Krugman, "Not Enough Inflation": But First There Must Be Demand

In his latest New York Times op-ed entitled "Not Enough Inflation" (http://www.nytimes.com/2012/04/06/opinion/krugman-not-enough-inflation.html?_r=0), Paul Krugman claims that higher inflation "would almost surely help the economy," but that Fed officials "are feeling intimidated." The benefits of inflation? Krugman writes:

"For one thing, large parts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years; this debt burden is arguably the main thing holding private spending back and perpetuating the slump. Modest inflation would, however, reduce that overhang — by eroding the real value of that debt — and help promote the private-sector recovery we need. Meanwhile, other parts of the private sector (like much of corporate America) are sitting on large hoards of cash; the prospect of moderate inflation would make letting the cash just sit there less attractive, acting as a spur to investment — again, helping to promote overall recovery."

I am not critical of Federal Reserve chairman Ben Bernanke, and I also don't see anything wrong with a little - emphasis on "little" - inflation, which reflects buoyant economic demand.

But given where interest rates currently stand, I question what tools can still be used by the Federal Reserve to engineer such demand and resultant inflation.

Inflation would reduce the real value of debt? Sure, but would banks respond passively to that threat and not raise interest rates? What effect would this have on borrowing? And what effect would this then have on stock market prices, whose decline would erode wealth and economic confidence?

Moderate inflation would make inactive cash less attractive and induce investment? Perhaps, but investment in what? Investment in gold or real estate would not in and of itself alleviate unemployment. Are corporations in need to new manufacturing facilities or equipment, or has manufacturing gone the way of the dodo bird in the US? Is new office space lacking? Not that I can see.

Bottom line, as Krugman surely knows, there are only paradoxes and no simple answers in our brave new world.

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