Saturday, November 10, 2012

Does the World Need an Inflation ?


Many economists have suggested over the past few years that there are essentially two policies that would help the developed countries out of their present situation of large deficits, large sovereign debt and low growth. Many have dared suggest that a combination of financial repression and moderate inflation are the path to salvation. Financial repression occurs when the Fed (Central Banks) maintain an artificially low interest rate . This lowers the burden of servicing the sovereign debt substantially. Ex: If the US national debt of $15 Trillion is to be financed at an average interest rate of say 7% then over a $1 trillion worth of interest will have to be paid each year. If on the other had the average interest rate is to be about 1% then refinancing burden would be only $150 billion i.e. a drop of about $900 billion. That is not bad. What do you think?


THERE have recently been a number of calls for a higher inflation target. The proponents claim that this would stimulate economic growth and also ease sovereign-debt crises. I have mixed feelings about these proposals. There are clear advantages to adopting more expansionary monetary policies in the US, Europe, and Japan, but it’s a mistake to target inflation directly, or even to describe the advantages of monetary stimulus in terms of higher inflation.

Inflation can rise due to either supply or demand-side factors. Because most consumers visualise inflation as a supply-side phenomenon (implicitly holding their own nominal income constant) they see inflation as a problem, not a solution. Thus any calls for a higher inflation target are likely to be highly controversial, which makes it unlikely they would be adopted by conservative central bankers.

A much better solution to frankly admit what a growing number of economists are saying; inflation targeting was a mistake from the beginning, and the major central banks should instead be targeting nominal income growth (preferably level targeting). All of the advantages of higher inflation (economic stimulus, lower real debt loads, etc.) are actually more closely linked to rising nominal incomes. A switch to NGDP targeting would not require the major central banks to adopt a new and higher inflation target, with the associated loss of credibility. Instead they should estimate an NGDP target likely to produce 2% inflation in the long run, that is, an NGDP growth rate target of perhaps 4.5% per year in the US, 4% in Europe, and 2.5% in Japan. If the central bank believes there is a need for some “catch-up growth” (and surely that’s the case in the US and Europe, then they should start the trend line from 2008 or 2009, to allow for higher NGDP growth for the next several years.

Some might argue that this is just a back door way of raising the inflation target. Not so. Inflation targeting is what got us into this mess. If we had been targeting NGDP in 2008, level targeting, then monetary policy would have been far more stimulative, the recession would have been much milder, and the sovereign debt crisis would have been confined to Greece and perhaps one other country. We don’t need an expedient like a temporarily higher inflation target, which will further erode central bank credibility. Rather we need an entirely new policy rule, a rule that will be so robust that it doesn’t have to be abandoned every time we face a recession or a debt crisis. A rule that is consistent with 2% inflation in the long run. Nominal income targeting is the policy rule that is most likely to fit that description.

16 comments:

Stephanie Cappa said...

What I do not like about nominal income targeting is that to set a rate meant for the future seems risky. the market changes daily and to know what the interest rate will be in months from that point seems like a very " normative" way of thinking. by setting the interest rate at "what it ought to be" and working towards it. i suppose it is a good goal but I personally think there are better economic policies that could get the economy growing. I also do not think inflation is the way to economic growth because with inflation comes a decrease in investment and savings which we are currently seeing in our market today.

Luis Lleshi said...

I agree with Professor Summer. It is wrong to simply rely on a stimulus to stimulate economic growth. I believe, just like a growing number of economists, inflation targeting was a mistake from the beginning. This stimulus actually ruins the banking system. Money that has been loaned out does not have the same value as it has after a stimulus in the economy. The banks lose money but the person who receives stimulus benefits. The way to fix this would be to switch to the NGDP, which would not require banks to adopt new and higher inflation targets and keep up with the stimulus.

Alberto Mancusi said...

Professor Summer is correct in his analysis of how targeting inflation would hurt the economy. Creating inflation would make it worse because it cannot be controlled as easily as just attempting to stimulate the economy. which increases inflation slowly and naturally. Most causes of recessions are inflation even though they do help reduce the debt crisis. it is still too risky to create an inflation rate especially when target inflation was the problem from the beginning.

Nick Ramos said...

In my opinion, inflation is unpredictable and not easily controlled. Use pre-World War II Germany for example. The inflation was ridiculous and unpredictable. By the inflation in the United States being elevated we may not be able to actually predict what will happen with the economy.

Imerlyn Ventura said...

I agree with Professor Summer at Waltham Bentley University that it’s a mistake to target inflation directly. Inflation is a temporary fix and brings serious consequences. The United States should look to a more long term fix like NGDP. NGDP would produce a long run inflation that won’t hit citizen quickly. This way they can adapt to the slowly increasing inflation and create growth at the same time.

Nick Terrasi said...

I agree with Professor Summer on his views about inflation. I think that creating an inflation would hurt this economy and we as the people will not benefit from it in the short term. I agree that we do not need to put a higher inflation rate in right away because the old rules that we have were always abandoned. I agree with Professor Summer that we need to introduce a whole new policy regarding inflation and how it will benefit our country for the long run. Our country needs a policy where they can count on it and not abandon it once a debt crisis or a recession comes along. However, I feel that there are other ways to make the United States grow besides having an inflation. I think that we should try other economic options first and if that doesn't get our economy to grow then last resort would to have an inflation. Once there is an inflation no one will be happy because the dollar that they have is loosing its value very quickly.

Kaitlyn Siriano said...

I agree with Professor Summer that inflation will be bad for the economy, but I do not agree 100%. I think some inflation will actually be good for an economy because it will help it get up and running. Too much inflation is bad because no one would be able to afford anything, and therefore the economy will crash.

Aaron Berube said...

I think the inflation approach to solving our debt crisis is the wrong choice. We cannot accurately predict how inflation now will effect us years from now, and although it may offer a short-term fix, it would not be worth the potential risks. I think the only way to pay down our debt is to work carefully and steadily to budget the money the United States is able to spend.

Blair Wynn said...

I don't think that higher inflation is a good idea. It is basically a gamble and we are not in any position to do such a thing. I think this will ultimately put us in a worse situation than we already are. Another thing is that a lot of people have loans in progress will earn more money than they are entitled to because of the change in value. I also think that people will spend more because they think the price of the goods will soon be too high. Ultimately the consumers will be effected, then the businesses, and it will back fire on the government.

Alison Wu said...

I think that Professor Summer makes a very strong point. Although inflation is very difficult to manage I do not think that targeting inflation is any good. If anything I think it would hurt the economy in the long run. Too much inflation would cause things to not be affordable and out of reach for many. If there is inflation it needs to be carefully managed and targeted at the right people. We should try different techniques before relying on inflation.

Chad Delgado said...

In my opinion, I feel the approach from financial repression is a good choice. Lowering the interest rate will always help when paying for debt. As for targeting moderate inflation, this would not be a very smart idea. The employment rate has not budged and people seem to be losing jobs as well. With the prices of our goods rising very few will have the income to support themselves. Investment will also lower if people cannot buy their everyday needs. I agree with Professor Scott Summer in targeting nominal income growth. Obviously the polices we have been using have not worked.

Tessy Punnose said...

I feel that we shouldn't have had inflation in the first place, because all it has done was cause us an economy that is not good for our nation. Just like Professor Summer states that we shouldn't have targeted inflation and instead nominal income growth, with the hope that we wouldn't have to cause an increase in inflation. The more we work with inflation the worse off we can be, and the more we try to control the variables that won't hurt us in the long run (the new policy), the better off we can be.

Destiny Reid said...

After reading this article, I agree with Professor Summers. I don't think that directly targeting inflation is good for our economy. It will just lead to more debt. Inflation is part of the reason why the US has over $16 trillion in debt. Of course inflation isn't always a bad thing. But, too much of anything can make something fail. If inflation is targeted, there will be more unemployment than there already is, people wouldn't be able to pay off their already owed debts, and surely, the country will go into another depression. Not only will consumers be affected, but the government as well. I agree that targeting nominal income growth is the better approach.

Anonymous said...

Louie Fortes said...
As we talked about in class and as this article says, "Inflation can rise due to either supply or demand-side factors. Because most consumers visualise inflation as a supply-side phenomenon (implicitly holding their own nominal income constant." I think that if the country wants to know how well we are doing than the NGDP is more accurate. If we wish to see how well we are doing in a closed economy than I understand how GDP is important as well.

Matthew Ramos said...

I believe that the Fed should responsibly control inflation as it correlates with the GDP, the rate of unemployment, and other important contributing factors. The issue in present time is that inflation is rising while we are in an economic recession. The unemployment rate in the U.S. lingers between 7% and 8%. People are struggling to find work and earn income. Now is not the time to continue to degrade the value of the dollar. I could understand a controlled increase in the percentage of inflation if we were experiencing a high level of economic growth from a stimulus, such as a technological advance, and/or a new international trade relation. Unfortunately, this is not the current situation. To start to resolve the issues we face and prepare for a better future, the Fed must take immediate action. They must carefully begin to taper off the rate of inflation, as we remain hopeful that the unemployment rate will continue to improve. Attention must be given to all the important factors that significantly influence the economic strength of our country, and inflation should be controlled at a proportional rate that correlates with those factors.

Jennifer Palladino said...

I agree with Popper when he says that economics is different than science. Science can be very predictable and is very exact. Economics can be studied, but not predicted accurately. In science, you can be assured that if you do the same experiment twice, you will always get the same results. With economics, there is not this consistency and reliability. Also, a big part of science is making hypothesis that most of the time come true, or some very lose to being true. Since economics is largely based on consumers, allocation, and scarcity, all variables that change on a daily bases, thus, all unpredictable.