Hooray for inflation

November 13, 2013

There have been some extraordinary headlines in recent days. Here’s the Economist: “The perils of falling inflation.” Here’s the Financial Times: “The eurozone needs to get inflation up again.”

For those with memories of hyper-inflation and “stagflation” in the 1970s, these cogent pleas for higher prices is heresy, an irresponsible clamor for the return of an ever-changing fiscal landscape that led to widespread misery and economic turmoil.

A little history. By the mid-’70s the Western world was engulfed in an inflation typhoon — with prices rising rapidly and out of control. As companies increased prices to keep up with the higher costs of basic raw materials — such as oil, deliberately hiked way beyond the norm by the Organization of the Petroleum Exporting Countries — trade unions demanded higher wages to protect their members’ standard of living. This led to higher costs, and higher prices, and so on.

The world became entangled in an apparently unstoppable upward spiral, like a crazy dog chasing its tail. Governments were blamed for it and broken by it, and new bold champions promising to slaughter the inflation dragon were elected in their place.

President Ronald Reagan here and Margaret Thatcher in Britain largely owed their precipitous rise to voters’ weariness with the curse of inflation. And they both turned to economist Milton Friedman as a savior.

A perceptive student of economic history, Friedman and Anna Schwartz concluded that inflation was caused neither by rising costs nor the push of increased wages, but the amount of money in the system. As Friedman put it, “inflation is always and everywhere a monetary phenomenon.” Monetarism was born and Keynesianism was put aside. A new Age of Inflation emerged — where inflation was the key indicator by which all government and central bank policies were measured.

It was not so much the Iranian hostage crisis that ditched President Jimmy Carter, but rather his failure to conquer inflation. He had appointed Paul A. Volcker, a Democrat, to be chairman of the Federal Reserve. But Volcker’s prescription — to deliberately trip a recession to reboot the economy, and then keep a tight control of the money supply — came too late to save Carter from defeat after a single term.

Reagan’s appeal for a return to “sound money” rang true with voters, and he kept on Volcker to finish the job. The result: inflation was licked, for a long while.

Fast forward to the fall of 2008, the collapse of the stock market and the freezing up of the financial system. Ruinous deflation became a serious risk. The emergency measures taken around the world, including the near $1 trillion injection of public money as a stimulus to keep the economy from total collapse, appeared to fly in the face of Friedman and all his works.

I say “appeared to” because Friedman is often misunderstood — not least by those who say they are devoted to him. Friedman and Schwartz had explored the reasons for the Great Depression and concluded that rather than the pricking of a stock prices “bubble,” as Friedrich Hayek contended, the slump resulted from too little money in the system.

Friedman thought President Herbert Hoover should have pumped vast amounts of cash into the system, through public spending or what is known today as quantitative easing (QE). Friedman’s embrace of ideas that are an abomination to today’s conservatives explains, in part, why his centenary last year was barely celebrated: Most conservatives have switched their allegiance from Friedman to Hayek.

Friedman’s main preoccupation was with inflation, but he was not against rising prices per se. He believed a certain amount of inflation was good for the economy — as long as it was kept in check. In practice, average inflation at or around 2 percent was considered optimum to keep the economy as a whole on track.

Inflation is good for business. It lubricates the wheels of commerce, allowing businesses to set prices at a level at which decent profits can be made. It automatically reduces wages over time, meaning workers have to return to employers each year simply to keep pace with the dropping value of their incomes.

But there are downsides, too. If inflation is too rapid, businesses find it hard to plan ahead and err on the side of higher prices, so as not to get caught out. People on fixed incomes, particularly those dependent on pensions and annuities, can slip behind as they watch their hard-earned savings melt away.

We are stuck now in a period of near stagnation, with growth ticking up but horribly fragile. Despite the Friedmanite prescription of QE, generously applied by Federal Reserve Chairman Ben Bernanke, Friedman’s most distinguished disciple, growth remains elusive. Coming out of a slump as deep and treacherous as the 2008 Great Recession was always going to be a slow affair and those who blame it all on the current administration only betray their ignorance — or cynicism. To suggest that high growth can be instantly restored by slashing government spending and paying off the national debt is as rational as the gobbledygook spouted at the Mad Hatter’s tea party in “Alice in Wonderland.”

With the Tea Party rump in the House preventing any fiscal measures by the administration, and with the European Union stuck in a deflationary spiral thanks to austerity, there is growing pressure on both sides of the Atlantic to try to energize economic activity by provoking inflation. So far, no one who can make that happen is listening, since they are still trying to keep the world economy from slipping into ruinous deflation and another general recession.

The European Central Bank last week reduced interest rates to a record 0.75 percent. Bernanke, after frightening the markets by hinting that QE would be “tapered” soon, is keeping interest rates low and has extended QE to the horizon. The message from the central banks is clear: if you are thinking of borrowing to invest and create jobs, be assured, cheap money is here to stay.

The central bankers are right. This is no time to pretend that all is well and that a little more inflation is in order. Inflation will return in its own good time. But right now a hike in interest rates would deter borrowing, undermine the frail housing market revival, kick the stock market in the teeth as investors rush to safer, more predictable savings havens, and stifle the mewling recovery in its crib.

So, enough with the talk of cranking up prices and interest rates. The best way to get the world spinning faster is to increase economic activity — not to slow it.

Nicholas Wapshott is the author of Ronald Reagan and Margaret Thatcher: A Political Marriage, and Keynes Hayek: The Clash That Defined Modern Economics. Read extracts here.


PHOTO (TOP): Plastic “Whip Inflation Now” button, for economic campaign started by President Gerald Ford.

PHOTO (INSERT 1): Milton Friedman. REUTERS/Courtesy University of Chicago

PHOTO (INSERT 2): President Barack Obama announcing his nomination of Janet Yellen (C) to head the Federal Reserve as outgoing Fed chair Ben Bernanke (R) stands by at the White House in Washington, October 9, 2013. REUTERS/Kevin Lamarque


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it’s important to keep inflation from falling too low because I’m leveraged up to my eyeballs buying assets that Mr. Bernanke has helped me purchase.

if my assets drop in value even a little bit………well, I can’t even talk about it. margin calls, bad loans, insufficient collateral.

now it seems to me, it’s worth starving and abusing the working population,.. so that me and my friends can own everything……

..after all financial speculators are the real citizens…….those other people are serfs or something.

Posted by Robertla | Report as abusive

Hasn’t the money supply been expanded with qe1,2,3? Nothing has come of all the money printing done by the fed. The economy still is in the tank. Hayek was correct – we are truly on the road to serfdom.

Posted by zotdoc | Report as abusive

For decades we grew our economy on frivolous consumption. People were encouraged to spend more on useless stuff. They didn’t save and learned to buy things that were designed to fail and to enjoy it. They followed their instructions well, but now are at the peak of their spending and earning capability (these good followers are not great acheivers and unlikely to be capable of an uptick in productivity). If we get any inflation now, some of the consumer/followers will be forced to curtail some of their spending, which will mean lower profits for business and less jobs. The Walmart workers are already incapable of shopping at Walmart. To get the inflation you want you’ll need to raise wages, or else you’ll teach them to consume less, and that is a slippery slope for the wealthy to go down. What would be worse, raising wages, or educating the american masses that frivolous spending doesn’t actually make their life better. Once the morons find that out, how long will it be before they learn a whole lot more about how they are manipulated?

Posted by brotherkenny4 | Report as abusive

“Friedman…believed a certain amount of inflation was good for the economy…at or around 2 percent was considered optimum to keep the economy as a whole on track.” On track to what, disaster? This is definitely a question of whose ox is being gored!

“Inflation is good for business. It lubricates the wheels of commerce, allowing businesses to set prices at a level at which decent profits can be made.” No, it’s not. Instability in commerce diverts productive effort to otherwise unnecessary silliness such as adjusting prices to maintain profit.

“It automatically reduces wages over time, meaning workers have to return to employers each year simply to keep pace with the dropping value of their incomes.” Once again, this diverts productive effort into dissatisfaction and never-ending negotiations with employees.

“But there are downsides, too.” You really believe the above is “upsides”? Certainly not for “we, the people”! “People on fixed incomes, particularly those dependent on pensions and annuities, can slip behind as they watch their hard-earned savings melt away.” Disingenuously WRONG! It isn’t a possibility they “CAN slip behind”, but a dead certainty.

For the last decade the interest paid by banks, etc has been too little to even preserve the purchasing power of “hard-earned savings”. At 2% per year, those on fixed income are 20% behind in a decade, 40% behind in two.

Most live in retirement 20 years, or more; and have NO way compensate for such fiscal management by THEIR government. Since older folks supposedly control 80% of the assets of this country, I think it’s long past time we figure out how to grab those responsible by the short hair and neuter their influence!

Posted by OneOfTheSheep | Report as abusive


“…educating the american (sic) masses that frivolous spending doesn’t actually make their life better?” What are we, oysters limited to the intellectual nutrients the currents carry by us? Please.

If the school don’t teach youth how to balance a checkbook, live within your income, use credit as a tool and not a balm, and avoid late charges maybe youth needs to divert some of the time they waste texting each other 24 hours a day and browse the immense amount of common sense available today on the internet. Yours is the logic of the young thing that steams into the bank, slams her checkbook down in front of the teller, and yells: “See? I CAN’T be out of money. I still have checks left!”

We are all born ignorant. The antidote is knowledge. Some is spoon fed us in school. The rest we have to acquire the old-fashioned way. We have to get off our butt and seek it out and then separate the wheat from the chaff.

You won’t earn credits for such a”course of study”, but the many who FAIL day after day need to look in the mirror and figure out the concept of PERSONAL RESPONSIBILITY on their own. Union teachers can’t pass on a concept they themselves don’t understand

Posted by OneOfTheSheep | Report as abusive

So, now we know that Milton Friedman was flat wrong as the Federal Reserve has been pumping trillions of cyber-dollars into the global financial system without creating inflation over the past six years.

How about acknowledging what a Nobel Laureate in Economics, Paul Krugman, has been saying for years – we’re in a prolonged Depression? Only the Tenth of One Percenters are doing well and that’s all that counts now that the Plutocracy completely controls the federal government through corruption and deceipt.

Citizens United? How about, Citizens Crushed?

Posted by ptiffany | Report as abusive


WRONG again. Most of the trillions of cyber-dollars have been siphoned off the top of the global financial system and funneled into government vaults and the fiat currency closest to holding value. That only works as long as that belief continues.

The day will come when other governments will not take our ink and paper for their tangible goods at full face value. The day will come when this ponzi scheme ends in a sudden run on the banks. Americans may yet have to have a wheelbarrow of our currency to buy a loaf of bread, and spend each day’s earnings before it’s worth halves again.

The tree that has stood strong for hundreds of years can weaken quickly and die from challenges it was never meant to endure. You are in no position to know anything about the strength of the dollar other than what you are told by people who are invested in this Ponzi scheme. Please.

Posted by OneOfTheSheep | Report as abusive

This article is a reminder how out of touch the think tanks are with reality. they should try buying fuel and groceries on paychecks that have remained stagnant for years and then talk about how inflation does not exist.

Posted by rikfre | Report as abusive

worldwide inflation is very very low

Posted by Leftcoastrocky | Report as abusive

” It automatically reduces wages over time, meaning workers have to return to employers each year simply to keep pace with the dropping value of their incomes.”

Sounds like economic slavery to me.

We are being led down the road to serfdom.

Posted by BioStudies | Report as abusive

Wapshott is right : deflation is a real danger. Look at Japan.

I’m as skeptical as everyone else that falling wages are supposedly a good thing, but here’s the real advantage to inflation: many industries are gradually made obsolete by the progress of technology etc. With 2% inflation, workers are forced to return to their employer every year to explain why they ought to continue receiving the same wages originally agreed: why are they still worth the same wages they were paid last year? It stops people from getting ahead of themselves so easily, imagining (like the coal miners did in Margaret Thatcher’s time) that the whole world will stop spinning if they stop going to work.

Plus, inflation makes the economically uneducated (i.e. most of the working classes) feel good about their “pay rise”. IT makes employers look kind-hearted when they offer 2% wage “increases” per year, and especially generous when they are willing to negotiate a 4% wage “increase” after a three-year pay freeze in return for “productivity improvements” and concessions in working conditions. It helps stop the working classes from rioting on the streets and smashing everything up.

Falling wages are not a good thing, but neither is a stagnant work-force that trained 40 years ago to work with the technology of that time, and thinks their skills should be worth just as much in wage remuneration in today’s economy as they were during the previous century — without any retraining or continual improvement on their part.

Deflation would offer us an extreme version of the “worker’s paradise” where, without any hard work, intelligence or action on the part of the worker, the value of money earned previously magically increases exponentially over time. Nobody bothers to trade because everybody just stuffs money under their mattress, waiting for it to appreciate in value. We don’t want to go down that road!

The pathological conditions for monetary systems are in many ways both self-sustaining (for a time, up to decades), and self-reinforcing (via feedback loops through people’s attitudes and habits). It seems, on a fair evaluation of history, that vigorous action is sometimes required to avoid these pathological conditions.

Wapshott mentions Friedman’s observation that wages are not the prime determinant of inflation rates; but rather, the amount of money in the system is the controlling factor. Perhaps this is true. It’s worth noting that inflation/deflation doesn’t necessarily entail wage reductions/increases. Rather, perhaps obviously, inflation/deflation is defined e.g. in terms of the rate of change in the amount of goods/services you can get for a fixed quantity of money, in some location, between two points in time. This might be considered a function of:
* Worker productivity,
* Worker wages,
* Demographics and market conditions (buyers/sellers market? Have all the workers been conscripted and sent off to war? etc.)
— The monetary solution (where there is one) is inextricably linked to these more basic factors.

Posted by matthewslyman | Report as abusive

p.s. “Nobody bothers to trade” — stop for a minute and think what that means: think “massive unemployment”.

2% inflation is just low enough that by the time uneducated workers are old enough to understand inflation by personal experience (and not just by sneering at quaint tales of “old money” from their grandfathers); they are too old to riot in the streets about it.

2% inflation is just high enough that the economy won’t stagnate due to decreasing competitiveness in a globalized, competitive market. It’s just high enough to stave off the very real risk of a vicious deflationary cycle (which is made all the more likely by advancing technology and automation).

Any higher or lower, and youth unemployment and disillusionment will be even higher than it already is!

So let inflation continue at 2% (subject to careful study by our central banks, about the true optimum level). Let the central banks do everything possible to keep the system in kilter. More goods being produced? Old technology going obsolete? More money in the system…

But let the working classes at least have a fighting chance of getting sound financial advice… Let us have a decent chance of retraining… Let everyone, rich and poor, work hard to improve themselves. Let everyone get training in how to negotiate a fair wage, and operate within a fair framework of fair trade where everyone has access to the strategic data, and where everyone has a stake in the success of their business.

Posted by matthewslyman | Report as abusive

…And Finally… A central truth that “sound money” advocates would never want to admit: 0% inflation, non-inflationary “sound money” is a lie. It’s DISHONEST! Why? Because in the real world, where money is not continually reinvested, the value of goods and services DECAYS! If you produce 1000 tonnes of wheat, there’s a good chance that some percentage of that will be destroyed by weavils (you don’t get more wheat unless you do work and plant/harvest it). If you produce 1000 tonnes of iron ingots and leave that in a warehouse for 100 years, you shouldn’t be surprised to find them a little rusty at the end of that, unless you spend a lot of money on a specially conditioned atmosphere to preserve them in their original condition. And so on.
So if we want our monetary system to be a reflection of reality (which it must be, if it is to be relevant, useful and productive); then there must be inflation.
The question is, what is the recommended RDA? What is the ideal amount of inflation? I reckon 1–3% PA depending on demographics and employment market conditions (I think 0–1% or 3–5% are just about acceptable, and anywhere outside 0–5% for more than 2 years would be quite disastrous)…

Posted by matthewslyman | Report as abusive

The reason the creation of new money has been neither inflationary nor very stimulative is that it has gone to the wrong people. Wealthy individuals and corporations have a low marginal propensity to consume (MPC). The lower incomes MUST spend each additional dollar of income while the others have the option of saving it. Wages are stagnant and unemployment remains fairly high. The solution is to tax the rich and give the proceeds to the poor. THEY will spend every cent of it – and produce a BOOM.

Posted by Ted180 | Report as abusive

As 2013 comes to an end, assuming no sharp market correction, it has been a great year to hold stocks and mutual funds – my funds have increased in value nicely compared to 2012

Are stock prices overvalued? I would prefer not to find out the hard way !

It would be a sound strategy for the US Fed to start tapering in early 2014 by $10 billion per month and HOLD to this game plan until the QE is phased out

The stock market would price tapering into prices to give investors a softer landing or modest correction

Without a shift in policy the $85 billion QE could now do more damage than good

It is time that stock prices reflected S&D fundamentals and sound management of companies

Moore, Garry R – Solutions Inc

Posted by GarryRMoore | Report as abusive