Monday, August 8, 2011

We Need Inflation

As most people realize by now, we aren't having a normal recession. It is very long and very deep compared to other recessions since World War II. Why?

One school of economists thinks they know. One is Ken Rogoff:

“The whole mentality of thinking of this as a recession leads to bad forecasts and bad policy,” he says. “It’s just not the right framework.”

Recessions, he argues, imply a very particular economic phenomena: a business-cycle recession, in which the drop is quick, and the recovery is usually similarly swift. That is not what we’re in. That is not what financial crises are. And mistaking one for the other has, in his opinion, cost us a fortune.

Financial crises are not about the business cycle falling out of whack. They’re about debt. Lots of it. And that’s why they’re so resistant to efforts to speed a recovery. Whereas you normally get out of a recession by lowering interest rates and persuading consumers to spend, the period after a financial crisis is marked by consumers trying to dig out from under a mountain of borrowed money. You can accelerate that process, but it’s hard to do.
And what is the best way to help people get out from under their debts? Inflation:
Since 2008, Rogoff has recommended that the Federal Reserve commit to an extended period in which it will seek to set inflation at 4 percent. That would effectively make debt worth less. That’s anathema to central banks, which have spent the past few decades building their credibility as inflation fighters. But Rogoff is unimpressed. “All the central banks of the world have been fighting the last war,” he says. “This is a once-every-75-years great contraction where you spend your credibility. This is what that credibility is for.”
I am quite certain this won't happen, because Americans hate inflation and American politicians are terrified of it. But it would be the fastest way back to economic growth.

And the best way to keep this from happening again is to limit how much money people and businesses borrow, via the sort of rules we put on banks in the 1930s and gradually abandoned during the boom years of the 80s and 90s.

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