Ben Walsh

Inflation is too low; how does it get too high?

By Ben Walsh
September 13, 2013

“Inflation can be too low as well as too high.” That was Fed governor Jerome Powell’s warning back in June. The data show that, based on the Fed’s own target of 2%, inflation is too low:

An interesting question is why post-crisis inflation has been so low, and what causes high inflation. Here’s a rundown of some of the debate.

Low inflation doesn’t seem to be for lack of effort

Mike Konczal made an important point in June. “Inflation is collapsing in 2013”, he wrote, despite the fact that “the Federal Reserve took extraordinary actions at the end of last year to hit its inflation target… The fact that inflation is falling even when more action is being taken should have us questioning whether a 4% move would have any traction”.

With that for context, there’s been an interesting debate over the last week about the origins of inflation in the 1970s, a time when 4% inflation would have been joyously embraced (instead it whipsawed from the mid-teens to mid-single digits and back again).

What if inflation is caused by factors the Fed can’t address?

Steve Waldman started the debate by asserting that “the great inflation [of the 1970s] was not at root a monetary phenomenon”:

The baby boom came of age at the same time as shifting norms about women and work dramatically increased the proportion of the population that expected jobs. The “malaise” of the 1970s was not a problem with GDP growth…. It was the people wut done it, by being born and wanting jobs.

Counterpoint: central bankers can screw up and cause too-high inflation

Scott Sumner objects to the idea that demographics caused 1970’s inflation and writes that, in his view, the Fed allowed “pointless inflation that doesn’t lower unemployment at all” and stands firmly by the idea that central bankers weren’t circumscribed by population factors beyond their control. Instead, they simply made errors and “were often clueless”.

High inflation can be the best-of-the-worst choice

Karl Smith takes a look at the actions of Arthur Burns, the man who ran the Fed in the 1970s, and concludes that he was actually very clued-in:

His general take seemed to be that unemployment was poisonous to the social fabric and that the social fabric was already strained, most notably by race relations. Further he felt that efforts to restrain inflation would be useless unless the power of the labor unions was broken. However, most of all he seemed to believe that the effect of monetary policy depended on the institutional framework of the nation and that this was in flux. Reading somewhat between the lines it seems he felt the worst of all possible outcomes would be that a leftist government would come to power and then render any attempt to control prices or sustain business confidence untenable.

That’s a fascinating view of monetary policy as being informed by a deep understanding of long-term cultural and social changes as much as economic data. (Relatedly, here’s the academic paper that jumpstarted Smith’s post).

Maybe growth and inflation seem to go together

Tyler Cowen looks globally and finds evidence that high growth and high inflation seem to appear in tandem, because inflation isn’t unpopular when wages are increasing, and because the credit supply is linked to future, not present, growth.

And back to demographics: old people love low inflation

Ryan Avent thinks that it’s difficult to separate cause and effect when looking at demographics and inflation, because “causation runs in both ways… and the key takeaway is the relationship between ageing and (dis)inflation”:

I’m a bit taken with the idea of high inflation as the fruit of a young, optimistic economy—and of low inflation or deflation as the choice of economies in the twilight of life, excessively cautious, with an eye on the past rather than the possibilities of the future… One starts to wonder whether a society, or a monetary regime, that always advantages the economic interests of the young isn’t preferable to one that simply caters to the modal generation across its life-cycle.

From that perspective, maybe low inflation is a greater threat to America’s future than the national debt.

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