Friday, August 20, 2010

The Inflation Phantom

Inflation in the US is running at less than 1%. The Federal Reserve, which used to have an inflation target of 3%, but lately for obscure reasons has reduced that target to 2%, is still worried about inflation even when their own stated policy indicates that they should be acting to raise it, not lower it. This is part of a weird longing for austerity that has gripped the world's financial leadership over the past year. Conservatives everywhere are howling for budget cuts and tightening the money supply, even as unemployment stays high and economic growth is sluggish, and many liberals are going along. But why? There is no economic pressure on the US or British government to cut spending. On the contrary, interest rates on government bonds remain at historic lows. There is no danger of inflation. What is it with the hard money yowling?

I think it is a psychological reaction to the economic crisis, or perhaps better a moral reaction. The crisis was caused, the argument goes, by excess -- too much borrowing, too much spending, too much easy money, too many unsound investments. To restore equilibrium, it is first necessary that we should atone for our excess. We must be purged by suffering before we can resume normal life. After feasting, we must fast. This sort of thinking is all the easier for bankers and economists to adopt because they are not suffering; as I have written about before, this recession has largely spared the well-educated. So they can soothe their souls with policies of austerity that don't hit their own pocketbooks. You can see how they would react to austerity measures that would actually impact their own lives by their policy on raising taxes; they are all on fire about reducing budget deficits, but only if it is done without asking them to pay another penny.

I believe that the business cycle is actually an emotional cycle. During boom times, people get excited and do irrationally exuberant things. When some of those crazy investments fail, or some of those expensive purchases become burdens, they over-react and plunge into gloomy austerity. It ought to be the job of central bankers and other economic leaders to smooth out the cycle with rational policies. As the current inflation hysteria shows, this does not work very well because bankers are just as subject to emotional currents as the rest of us.

No comments: