Dan Alpert's Two Cents

Dear Paul (Krugman) Letter: Inflation Would be Dandy – But Try to Make it Happen

A couple of days ago, Paul Krugman published a blog post in which he slammed a column that his fellow Paul (Volcker) had written for The New York Times in which he, unsurprisingly, warned of the dangers of inflation.

While I agree with Professor Krugman that inflation today is no danger, and would arguably be welcome, the notion that it is possible to engineer seems a non-starter to me. I offer the same concern to Ken Rogoff, whom I admire greatly, on his proposition that all we need is a period of sustained inflation at 4% to 5% and we’ll be off on our way out of debt deflation and back to growth. If only it were that simple.

Below is the note I posted back to Krugman in the Times, and following that is a little graph of what happened the last time we tried to engineer inflation and wages didn’t follow along:

“Dear Paul:

I agree with your analysis, but believe it a little (no insult intended) “academic.” If we could engineer roughly coincident price and wage inflation, you and Ken Rogoff would be spot on. But I see none of conventional, quantitative or direct credit easing as sufficiently countering the combined forces of debt deflation and the “supply shock” (reverse of the ’70’s variety) caused by excess global labor, productive capacity and capital.

That we should not fear inflation is quite accurate. But equally so is the fact that we can not engineer it without directly increasing demand relative to the oversupply. “Directly” as in re-employment of our idle labor and capacity in the hope that the additional demand resulting therefrom will absorb at least some of the excess supply.

Which of course leads me to your general premise – that fiscal intervention targeted at employment is the only tool left in the box. I agree, it is the only tool left and we must use it.

Nevertheless, the size of the global imbalance (we are, alas, no longer in the relatively closed EuroAmerican system of Keynes and Hayak) may, I fear, even challenge government creation of millions of additional jobs. Let’s say a trillion of spending over 5 years might increase payrolls by about 5 million – good rule of thumb. It would help (and we can get some pretty brand spanking new infrastructure out of it to further improve productivity), but can that really fully forestall some degree of wage – and therefore price – deflation to restore US global competitiveness?

Therein lies the challenge. If the normal transmission mechanisms to restore balance (devaluation and protectionism) are effectively off the table as I believe them to be, isn’t the only remaining mechanism inflation in the creditor/surplus countries and disinflation/deflation in the debtor/deficit economies? The latter condition occurring, again, to the extent that induced job creation is insufficient to sufficiently offset global oversupply.”

And below is the graph I mentioned:

One Response to “Dear Paul (Krugman) Letter: Inflation Would be Dandy – But Try to Make it Happen”

drderrickOctober 20th, 2011 at 10:50 am

People with inflation-linked secure jobs arguing for "managed" inflation. They should no better. Inflation is theft. It is a transfer from prudent savers to the profligate debtors. How does rewarding and encouraging debtors help to solve a crisis caused by an excess of debt? How does an economy recover when the savings needed for investment are stripped away?