Ben Bernanke and Paul Kruman have written on the dangers of deflation and the implicit importance of some level of inflation. Generally this has been in the context of dealing with a liquidity trap. Ken Rogoff has a different angle suggesting that “a sudden burst of moderate inflation would be extremely helpful in unwinding today’s epic debt morass.” Rogoff is not your standard inflation dove. Rather the opposite. In a quite personal spat with Joe Stiglitz in the early naughties, he referred to “the great Paul Volker” who crunched US inflation with tight monetary policy and a nasty recession in the early 1980s.
Of course Rogoff doesn’t think inflation is a nice thing in normal circumstances (or rather any more than very low rates of inflation consistent with current targets). His case for it is that it’s the lesser of evils for economies that are mired in toxic paper and debt.
Modern finance has succeeded in creating a default dynamic of such stupefying complexity that it defies standard approaches to debt workouts. Securitisation, structured finance and other innovations have so interwoven the financial system’s various players that it is essentially impossible to restructure one financial institution at a time. System-wide solutions are needed.
Moderate inflation in the short run say, 6% for two years would not clear the books. But it would significantly ameliorate the problems, making other steps less costly and more effective.
True, once the inflation genie is let out of the bottle, it could take several years to put it back in. No one wants to relive the anti-inflation fights of the 1980s and 1990s. But right now, the global economy is teetering on the precipice of disaster. We already have a full-blown global recession. Unless governments get ahead of the problem, we risk a severe worldwide downturn unlike anything we have seen since the 1930s.
I guess what matters is how much inflationary expectations get built into the system during the period of outsize inflation. If they do, no-one knows any neat ways to lower inflation without a (further) recession. I’m glad we don’t look like having to make any such difficult choices here – if we play our cards right. The Government, the Opposition and the unions think a plan to temporarily cut compulsory super – which won’t cost the government a dime and allows everyone who wants one an ‘opt out’ and which will lead to a one third rise in super contributions after seven years – is too left field.
In his spat with Stiglitz, Rogoff said this:
Joe, you may not remember this, but in the late 1980s, I once enjoyed the privilege of being in the office next to yours for a semester. We young economists all looked up to you in awe. One of my favorite stories from that era is a lunch with you and our former colleague, Carl Shapiro, at which the two of you started discussing whether Paul Volcker merited your vote for a tenured appointment at Princeton. At one point, you turned to me and said, “Ken, you used to work for Volcker at the Fed. Tell me, is he really smart?” I responded something to the effect of “Well, he wasarguably the greatest Federal Reserve Chairman of the twentieth century” To which you replied, “But is he smart like us?” I wasn’t sure how to take it, since you were looking across at Carl, not me, when you said it.
I must say I don’t much like this adulation of ‘smart’ but then there you go. I would say that in company like that wouldn’t I? Of the characters in the story, Joe has a Nobel Prize to his name. But judging from Ken’s modest aside in telling the story, you wouldn’t know that he’d been a chess grandmaster managing second in the US Open. Here he is knocking off Jan Timan who was regarded by some as the best chess player outside of Russia, though there’s more fireworks in this game against Rudy Blumenthal. And if you want to see someone make a complete monkey of him in 26 quiet positional moves, try this.