Unemployment Hurts More Than Inflation: David G. Blanchflower
Commentary by David G. Blanchflower
June 15 (Bloomberg) -- Oh, for a little inflation!
I don’t mean barrow loads full as in Germany in the 1930s or recently in Zimbabwe, but 4 or 5 percent a year for a few years would work just fine and would really help us to get out of this mess. It is doubts over the variation in price changes that create difficulties rather than the level, at least up to a point.
Inflation does redistribute wealth from savers to borrowers, but right now that would be a pretty good thing. Many borrowers are in big trouble and need help. Savers can always plump for inflation-linked securities and cost-of-living adjustment clauses can be inserted into wage contracts. Inflating our debt away looks pretty attractive given the lack of good alternatives.
Allowing inflation to rise a little was also advocated recently by Olivier Blanchard, chief economist at the International Monetary Fund. His main argument was that it helps to deal with the zero-bound problem, where interest rates really ought to be negative but it isn’t feasible since zero is as low as they can go. You get around this by letting inflation go up a bit and eventually interest rates will rise. You then have some room to maneuver rates down if and when economic activity falls.
All the other options look much worse to someone like me who cares about unemployment.
Trade Offs
The unemployed are especially unhappy, but unemployment also makes the employed unhappy. There is a growing literature based on happiness data which suggests that in boom times unemployment hurts twice as much as inflation -- a so-called misery index of 2-to-1. In a bust it may well be even higher than that. If the choice is between more inflation and less unemployment or less inflation and more unemployment, I choose the former.
Inflation would reduce the real value of public and private debt. And importantly it would help to push many of those homeowners who are in negative equity back into positive territory. And what exactly is Plan B to deal with this problem of negative equity?
There is little or no recent evidence from any developed country that inflation at today’s levels ever turns into anything catastrophic. Hyperinflation isn’t on the cards. If there is a sign that it is appearing then we know what to do; reverse quantitative easing and raise interest rates for a while and tighten our belts. Fears that moderate inflation quickly turns to hyperinflation are unfounded based on the data.
Not Easy
Creating a bit of inflation turns out to be pretty difficult right now even with all the monetary and fiscal stimuli governments around the world have been throwing at their economies. Last month in the U.S. the consumer price index on a seasonally adjusted basis fell by 0.1 percent. The producer price index also fell by 0.1 percent on the month.
The big worry that really has to be avoided, though, is deflation, as consumer spending is falling, banks aren’t lending and wage and income growth is benign. Price changes are already in deflationary territory in Ireland (-2.5 percent), Latvia (- 2.8 percent) and Japan (-1.2 percent). Inflation is less than 1 percent in Portugal, the Netherlands, Slovakia and Lithuania.
The inability to create inflation after all of this stimulus just illustrates the immensity of the shock we have experienced.
The outlier is the U.K., where consumer price inflation hit 3.7 percent in April, forcing the monetary policy committee to write to the chancellor to explain why. The MPC traced the rise in inflation to a) the increase in the value-added tax to 17.5 percent at the start of the year from 15 percent, b) a rise in energy prices and, c) the fall of the pound.
Deflation Threat
The MPC’s central projection in its most recent forecast though is that inflation will decline and there still remains a substantial probability of deflation.
The bottom line if you want some inflation is that you need to keep interest rates low, probably accompanied by significant amounts of quantitative easing for a long time. The Federal Reserve has made it clear that this is its position and it’s in a wait-and-watch mode. The Fed has said that rates are likely to stay near zero for an “extended period.”
In an op-ed earlier this month Charlie Bean, deputy governor for monetary policy at the Bank of England, argued that the “U.K. that must not fall for the false promise of higher inflation.” He is dead wrong -- fears of inflation are from a bygone era. Targeting inflation didn’t prevent countries, including the U.K., from getting into this mess and it may well have exacerbated it by taking policy makers’ eyes away from the real problem of over-leverage.
Inflation is the only show in town right now. Monetary stimulus needs to continue and if that means more inflation that would be fine, certainly for now. Interest rates of 1 percent or lower for the next five years seem about right. And on top of that central bankers may well need to do lots more quantitative easing, especially if governments embark on policies of cutting spending based on what economist Paul Krugman has called “utter folly posing as wisdom.” Unemployment hurts.
In today’s world, massive unemployment hurts a lot more than a little bit of inflation.
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