Inflation Is a Valuable Tool. Too Bad We Can't Use It.
What if higher inflation were to resume? After all, recent forecasts have suggested the possibility of 4 percent inflation for the U.K., and in the U.S. core inflation is already slightly above 2 percent. Possibly there is less deflation coming from China, and the latest report on U.S. gross domestic product shows that economic growth may be heating up.
My biggest worry is about the politics, not the economics. I am not sure that the American system of government, in its current state, could handle a vigorous debate about inflation, which has become a tough sell.
If a negative shock hits the economy, typically the Federal Reserve should opt for monetary easing to boost credit and labor markets, even if that means higher inflation. Attempts to suppress the inflation rate mean the economy is hit by negative demand and supply shocks at the same time, and can create a macroeconomic disaster, such as happened during the oil price shocks of the 1970s. But the next time such bad news comes, it may be hard to pull off the appropriate response. People don’t seem willing to accept higher prices, even if beneficial to the economy.
Just think how the U.S. has changed. Compared to earlier decades, economic growth and wage growth have slowed, the population has aged, average job tenure is longer and Americans are much less likely to move across the country for a new job. Furthermore, more Americans have ensconced themselves service-sector jobs, where they're sheltered by formal tenure or strong networks of allies at work. We are more set in our ways, and that means people with jobs feel more threatened by inflation.
In the rarefied world of economic theory, higher inflation would translate into higher nominal wages fairly quickly, keeping the real, inflation-adjusted wage constant. But that doesn’t happen automatically, because employers will only pay their workers more if they fear those workers will leave or rebel. With lower levels of labor-market and geographic mobility, and with more two-income families, it's harder for many workers to threaten to quit than before.
The net result is that inflation would leave many workers with permanently lower wages, as in essence the central bank would be giving them a wage cut that their own employers probably would not have dared. Maybe wages would adjust upward over the years, but workers would not be guaranteed this recompense.
Higher inflation in essence is asking workers to renegotiate their underlying deals, and many people – even if they are quite productive – know that a new round of renegotiation won’t necessarily operate in their favor. Inflation is easier to sustain politically in rapidly growing economies where people are moving up ladders quickly and renegotiating their deals all the time.
We’re living in a time when American workers already feel threatened by foreign trade and automation and immigration; those perceptions are real even when they are based on incorrect or exaggerated readings of the underlying facts. A higher inflation rate would add a new culprit to the mix. Debates over the Fed and monetary policy would become more politicized, another of the farces and circuses that have plague American political discourse.
In bad times, inflation can help the unemployed and the potentially unemployed while hurting people with steady jobs. Even in bad times there are many more people with jobs, and those individuals are also more likely to vote. The indirect pressure on the Fed, operating through voters and Congress, is likely to favor the majority interest. The final result is probably that, in bad times, money will stay tight, the losers will suffer more, and inequality will rise.
In the U.K., Bank of England Governor Mark Carney has kept interest rates low to deal with the fallout from Brexit, thus implying a higher inflation rate for awhile. He’s been attacked for that and suddenly the news is that he’ll leave in 2019 after six years in the job instead of the usual eight. As for the U.S., higher inflation is coming sooner or later. When it does, there will be strong political pressure on the Fed to keep money tight.
For now, inflation and monetary policy seem to be going reasonably well. The less positive underlying reality is that we have painted ourselves into a corner where, in an inflation-averse political climate, monetary easing may no longer be a viable option when needed.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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