Is price stability immoral?
Steve Waldman is one of the most original thinkers on the internet, and I highly recommend you read his latest piece, “Stabilizing prices is immoral“. You might never think about central bankers quite the same way again, and indeed you could start thinking that they judge themselves according to how assiduously they service the interests of the rich and well-employed.
When central banks see consumer prices rising too fast, they raise interest rates to bring inflation back down under control. That’s a deliberate slowing of the economy as a whole, for the especial benefit of the kind of people who have a particular interest in low inflation. The beneficiaries, here, are lenders, and people who can’t assume that their salaries will rise with inflation. Meanwhile, debtors — and even the economy as a whole — would have been better off, at least in the short term, if the central bank hadn’t acted at all.
Now central banks act the other way, too: they cut interest rates when demand is too low. And when that happens, as Waldman says, the tables are turned:
Whether monetary or fiscal, an antideflationary response to a supply shock implies an increase in aggregate demand which helps keep marginal workers employed. Creditors and secure-but-stagnant job-holders lose out, as the increase in purchasing power they otherwise might have enjoyed via deflation is distributed to other parties.
So, what goes around comes around, right? Not so fast. I’m reminded of when I spent a lot of time looking into the equity premium — the excess return that investors get for holding stocks rather than bonds. Given that the equity premium exists, why doesn’t it get arbitraged away? A lot of the reason is that the premium has an annoying habit of turning up exactly when you don’t need it, and disappearing exactly when you do. Stocks do well when the economy is booming and lots of people have jobs and are getting raises. That’s when they don’t need to turn to their nest eggs. Conversely, in recessions, when people get laid off and need cash, stocks have a tendency to fall quite sharply, even as bonds do rather well.
As a result, there’s a good reason why investors like having bonds in their portfolio, even if they expect those bonds to underperform: there’s much more value to something which does well in bad times than there is to something which does well in good times.
And this is Waldman’s thesis about price stability: it helps out rich lenders in bad times, and helps out poor borrowers just when they don’t really need it.
Under a symmetric policy, creditors and the securely employed purchase their insurance against bad times by foregoing some benefit during good times. That’s still a fine deal. Their overall risk is reduced.
But the opposite is true for debtors, taxpayers, and marginal workers. Just when these groups need a break, when the economy is bad due to an adverse supply shock, they are hit with additional costs in the name of price stability. Sure, when things are good all over, they get some frosting on their cake. Their highs are higher, but their lows are lower. Symmetrical price targeting turns debtors, taxpayers, and marginal workers into high-beta speculators on the state of the broad economy, while reducing the risk exposure of creditors and secure workers. It represents a vast subsidy, a transfer paid in risk-bearing, from debtors, taxpayers, and marginal workers to creditors and secure workers.
But, I’m not completely convinced. Adverse supply shocks notwithstanding, the general rule is that central banks cut rates in bad times, and raise rates in good times. When they cut rates, that’s bad for lenders and good for borrowers. When they raise rates, that’s good for lenders and bad for borrowers. So if you’re a rich lender, you’re unhappy in bad times and happy in good times. Far from insuring the rich against bad times, the central bank seems inclined to kick them when they’re down.
What’s more, over the long term, economies tend to do better if they grow steadily: volatile inflation does no one any favors, compared to the alternative.
Still, I like Waldman’s idea of a government savings account paying 0% real interest to anybody with less than $200,000 to invest. It should be easy to invest your savings so as to protect their purchasing power; in fact, it’s hard. Back in 2010, I asked the world to invent a Gross World Product swap: basically, big multinational corporations could fund themselves at the rate of growth of the world as a whole, while risk-averse investors could buy a proxy which would very closely track global purchasing power. That hasn’t happened yet. So for the time being, a simple index-linked savings vehicle would be a great start. And, as Waldman says, it would be easy insurance against exactly the kind of supply shocks that Waldman is worried about.