Don’t panic: a little inflation isn’t a bad thing
The writer is professor of economics and public policy at Harvard University and former chief economist of the IMF
Is a modest surge in post-pandemic inflation necessarily a bad thing? With the United States experiencing high inflation (5.4% in the 12 months ending in June), there is growing talk of an Inflation Armageddon if the Federal Reserve falls too far behind. There are real risks. But maybe after a decade of below target inflation, a few years slightly above target, say 3%, could be a good thing.
US inflation today is more good news than bad. Prices are rising mainly because the US economy is doing much better than it seemed possible a year ago – thanks to an early and aggressive supply of vaccines to the US, continued macroeconomic support, and a surprisingly shifting shift. successful at remote work.
It is hardly shocking that there are all kinds of temporary bottlenecks. Last year, Hertz, the car rental company, declared bankruptcy; this year, with people wanting to travel again, rental car prices have skyrocketed. When the quarantine is over, suddenly everyone wants tradespeople to come into their homes to make repairs and make improvements. The wait times for refrigerators and washing machines are extremely long, even as their prices have increased dramatically. The labor market is tight, wage growth is strong and is likely to intensify.
Would we feel better if the economy was much weaker and inflation lower? Sustained inflation can be a risk as the economy has come out of its deepest hole since the Great Depression. But an unexpected setback in the fight against the pandemic is a greater risk.
Across much of the United States, there is a palpable sense that the pandemic is over. But it is a very parochial vision. It is true that in the United States, just about anyone who wanted to be fully immunized was able to do so; the vast majority of the unvaccinated simply chose not to be. (Don’t ask me why.) Yet the pandemic is far from over. Two-thirds of the world’s population who do not live in an advanced economy or in China are in dire straits. They can only wish that their biggest worry was inflation – although in countries like Argentina inflation is also out of control.
In 2008, as the financial crisis unfolded, I argued insist that central banks should relax their inflation targets by 2 percent and temporarily target inflation of 4 to 6 percent for a few years. If they had moved quickly and adopted effective negative interest rate policies, I think it would have been possible. Higher inflation for a few years would have helped stimulate demand and ease the unsustainable debt burden of many countries. (Another first-rate policy would have been to write off subprime mortgage debts in the United States and make unconditional transfers from Northern Europe to pay public debt depreciations in peripheral countries such as Greece and Portugal.
Today the situation is different. Because the US Treasury and the Fed have intervened so quickly and proactively, there have actually been fewer business failures in 2020 than in 2019. Since bankruptcies normally rise sharply during a recession, this It certainly sounds like too good news.
But even with debt problems contained, there are still benefits from temporarily higher inflation. Most importantly, the Fed must occasionally allow inflation above target – if that’s serious when it says it’s aiming for 2% on average. Many had started to wonder if this was possible. After the inflationary drought of the last decade, a light downpour is welcome. Making the Fed’s inflation target more credible should help push the structure of interest rates up and give the Fed more leeway to reduce them in the future.
In fact, economic theory gives very little solid guidance on whether, say, 3% inflation is better than 2% in normal times, as long as it remains reasonably stable and predictable. When Olivier Blanchard was the IMF’s chief economist in 2010, he argued that inflation targets should be raised to 4%.
Sustained inflation of, say, 3% would also provide an opportunity to reconsider the Fed’s current 2% target. The idea is hardly radical: some central banks like Australia and Hungary already have a inflation target and others like the Bank of Canada have considered the idea. It’s true, as I have long argued, a much more elegant way to give central banks more leeway to cut through a deep recession is to properly prepare the ground for negative interest rate policy, but I’ll leave that to another day.
I have highlighted the positive aspects of moderately higher inflation over the past few years. But there are risks. What matters most is whether the unlimited expansion of public spending and transfers is not substantially (it does not need to be fully) offset by higher taxes. If the global cost of borrowing were to rise unexpectedly, the higher cost of servicing the larger debt could lead to government pressure on the central bank to keep nominal rates low, which would risk cause inflation which will eventually become severe.
For the moment, the markets seem utterly indifferent – almost too much given the pervasive uncertainty surrounding the global economy as the pandemic emerges. Yet, at least for now, slightly high inflation is more likely to indicate that things are going well than that we are doomed. There is no reason for the Fed to crush it too quickly.