For roughly the last week, Paul Krugman has been focused on the recent International Monetary Fund World Economic Outlook report and its suggestion that our current inflation target of 2% is too low. He talked about it in his column today, Oligarchs and Money. The point is that having such a low inflation target is currently keeping our economy depressed. Let me explain the basics here.
I remember reading a libertarian book many years ago. One chapter advocated the gold standard. It countered the idea that the economy needed more money as it grew, because if the money supply remained constant, the value of money would go up. There would be deflation rather than inflation that we are more familiar with. Problem solved! It is entirely typical of libertarian arguments because it is so neat and tidy while also being completely wrong.
Deflation is a bad thing for a number of reasons. The first is that it discourages economic growth. If you can make money by just stashing dollar bills in your mattress, there is a real disincentive to buy stuff. And that leads to much lower demand and fewer jobs. What’s more, it discourages investment and borrowing. Because of inflation, just by paying the interest on a loan, the principal is reduced over time. In an economy with deflation, you would owe more and more over time. It also makes it very hard for people who are in debt to get out of debt.
There is a group that loves deflation, and this is what Krugman is primarily on about. People who already have a lot of money like deflation because it effectively rigs the system in their favor. Their bonds and loans and cash just go up in value without doing anything. But they haven’t managed to get deflation as a stated policy, but they’ve been very good at getting super low inflation which is almost as good.
But here’s the thing. There is nothing especially different between low inflation and low deflation. Inflation is a statistical measure. So an inflation rate of 0.1% might indicate that 51% of goods are rising in price while 49% are falling. A deflation rate of 0.1% would be the reverse: 49% of good are rising in price while 51% are falling. So right now, Europe has an inflation rate of less than 1%. In the United States, it is less than 2%. These are both bad because they are stifling economic activity in the same ways I discussed above about deflation.
The situation is very clear, but don’t expect anything to be done about it. This is because we really don’t live in a democracy. The interest of the rich are pretty much all that matters. And in case you haven’t noticed: the last five years have been really good for the rich. It’s probably the main reason that I find politics so depressing. Humans are really smart and can generally figure out solutions to problems like global warming or a bad economy. But nothing is done because we can’t figure out how to equitably distribute power.