View Full Version : The Need For Benign Inflation
The Need For Benign Inflation, Thursday 26th June
An inflation is needed for two reasons. One is that, as energy prices rise in relation to labour, the cost of everything needs to change by differing amounts, and the only pleasant way this can happen is if all prices move up. The other reason is that the burden of debt being carried in Ireland has got out of step with incomes. Asset values are also out of line. An inflation would correct both relatively painlessly. But who would create the money which allowed the inflation to happen?
The ideas I expressed in my Feasta seminar last week on "The Need for a Benign Inflation" have been called "wicked and stupid" by Professor Martin Wolf, the well-respected economic commentator on The Financial Times. He was reacting not to the seminar itself but to an article I wrote on the need for an inflation in Ireland while preparing my talk. The article was subsequently printed in the Sunday Business Post.
The attachment to this message contains the article itself and the ding-dong exchange of e-mails which followed, mostly between Wolf and Brian Davey, although I and Professor Willem Buiter of the LSE, a former member of the Bank of England Monetary Policy Committee, joined in.
The Outback Oracle
09-01-08, 05:23 PM
Is this an Irish joke and meant to be in the jokes section?
Not really -- from the paper linked
(In early June, Brian Davey sent a copy of an article of mine to Professor Martin Wolf a well respected columnist on The Financial Times and to Professor Willem Buiter of the London School of Economics, a former member of the Bank of England's Monetary Policy Committee. The article later appeared in the Sunday Business Post.)
Ireland badly needs an inflation at present and yet the the European Central Bank is threatening to raise interest rates to prevent us, and the rest of the eurozone, from having one. The ECB regards inflation as a serious disease but its proposed cure will do far more harm than good. Let me explain.
There are two reasons why an inflation is necessary. One is that energy prices have gone up and businesses of all sorts need to pass on their increased costs. If they are allowed to do so, the prices of products made using a lot of energy will go up by more than those made with a little.
We, the consumers, will then buy more of the lower-energy goods and services and less of the high energy ones. The market will work. The new set of price differentials will shift the whole economy towards a lower level of energy use.
But Jean-Claude Trichet, the President of the ECB, is threatening to stop the market working. Worse, the higher interest rates he wants are inflationary themselves because they will increase business costs.
His higher interest rates are intended to discourage borrowing and thus reduce the amount of money in circulation. This will automatically cut business profits because there will be less money around for firms to divvy up at the end of their financial years.
Moreover, in the present circumstances, a reduced money supply will cut demand just at a time when demand is falling anyway because the higher fuel prices are already leaving less money in everyone's pockets.
Trichet's proposal therefore risks pitching the European economy into a recession. Businesses will find that their energy and interest charges have gone up and their sales and profits have gone down. Many will be forced to lay off workers and scrap their capital investment plans, making even more people unemployed. And the newly-unemployed will have less money to spend, reducing demand even further.
The fall in demand will undoubtedly reduce Europe's energy use, particularly as the cancelled construction work would have taken a lot of energy. However, the drop in eurozone fuel use may have no discernible effect on world energy prices. These are likely to move higher still because of rising demand from other parts of the world and a declining supply - it is almost certain that world production of conventional oil has passed its peak and is set for a long run fall.
By fighting this particular inflation, Trichet is trying to maintain the price of oil constant in euro terms at a time when it is becoming scarce and the market is putting its price up. The only painless way that he can win his fight is if the eurozone can increase its energy efficiency at the same rate as the oil price rises. But, since the price of a barrel of oil in euro terms is now five times what it was ten years ago and three times its level in 2004, that's clearly impossible. As a result, profits and wages will have to fall to give him the price stability his political masters have told him to achieve.
The second reason Ireland needs an inflation is that we've borrowed too much and unless we are allowed an inflation to reduce our debt burden, our banks will find themselves in difficulties and the money we have deposited in them may be lost. If that sounds extreme, look at Table. 1
The Outback Oracle
09-01-08, 10:55 PM
G'day Rajiv..I did not mean to be insulting! I've had a fair spray about this inflation argument elsewhere so I will refrain here for the moment.
Suffice to say that I think inflation is totally amoral and anyone who thinks they can solve anything with it is totally deluding themselves
"Nothing comes from nothing
And nothing ever will"
As I commented in my other post people who promote inflation as some sort of fix-it for debt really shake my branch!
BTW I did print our your reference and read it is detail,
I am not necessarily disagreeing with you philosophically.
However, an inflation free society cannot happen in a debt based fiat currency monetary system. For that severe monetary reform is required, and I do not see that happening anytime soon.
If you note the headline "benign inflation" -- that I believe is the best one can hope for in the current system.
The Outback Oracle
09-02-08, 01:47 AM
Rajiv...that's an oxymoron....benign inflation
OK my son (who is wiser than me) always warns me about making investment decisions on the basis of what OUGHT to happen rather than what the scum bags are going to try to pull off. I'll go through your post (both sides) carefully and try to write someting more cogent. I tip that you are right and what you describe is what these amoral self-seeking morons are going to try for.
Meanwhile a short comment...
In this case inflation is only going to make more debt, personal, business, national, international, as there is no consideration to having interest rates that would cover a satisfactory return for postponing consumption, paying tax and compensating for inflation. Therefore people will just make the rational decision, as they do now, to spend the useless papaer before it devalues even further. They will also borrow more to do so although I grant, in the short term, there may be time lags due to changing propensities to save through recessionary times. In the medium to long term however inflation, without positive real interest rates, after tax, will just result in more debt.
Conclusion in the end is the usual one...it's a race to the bottom with all its resulting social upheaval.
The only way to fix debt is to stop spending. It doesn't matter whether it's personal debt, business debt, or national debt. The piper is going to be paid.
What this bloke is doing is trying to make those who least able to pay bear the burden. His argument that he can somehow compensate those who will lose by the inflation (price increases), while at the same time increasing both wages and business profits, while presumably not creating more debt, is about as sensible as believing the fairy godmother will fix it all.
Powered by vBulletin® Version 4.2.1 Copyright © 2014 vBulletin Solutions, Inc. All rights reserved.