Bits Bucket for July 21, 2012

Lots of economists seem fine with the “screw the seniors and bond owners” easy way out of the Great Recession.

To his credit, Ben Bernanke is not among them.

Those who advocate higher inflation seem happy enough to overlook the moral hazard problem associated with painlessly letting debtors off the hook, which is that another generation of profligates will feel encouraged to assume unrepayable financial obligations, recognizing that they, too, will soon enjoy a credit bailout in one form or another.

Not only seniors and bond owners will get shafted, but also American workers. This isn’t the 1970s, when union contracts covered many American workers with COLAs. Raise wages now, and the production effort will simply shift elsewhere in the global economy.

July 21, 2012, 5:00 AM

Number of the Week: Could Inflation Revive the Recovery?
…
In a speech last fall, Chicago Fed President Charles Evans laid out the argument this way: The Fed’s implicit inflation target is 2%. The Fed doesn’t have a widely cited numerical target for unemployment, but a conservative estimate of the “natural,” or underlying, rate of unemployment is 6%.

“So, if 5% inflation would have our hair on fire,” Mr. Evans said in September, “so should 9% unemployment.”

Unemployment has come down some since last fall, but it’s still at 8.2%, nowhere close to the Fed’s “maximum employment” mandate. By Mr. Evans’s logic (which he explains more fully in his speech), the current rate of joblessness is equivalent to inflation running at 4.2% — more than double the Fed’s target rate.

Mr. Evans has argued the Fed should consider allowing inflation to run above its target until unemployment falls to some pre-determined — and pre-announced — level. He got more support for that position this week from economists Menzie Chinn, of the University of Wisconsin (and also the blog Econbrowser), and Jeffry Frieden, of Harvard. In a new article in the Milken Institute Review, the two economists argue that if fiscal stimulus, quantitative easing and an alphabet-soup of mortgage relief programs haven’t been enough to kick-start the recovery, it’s time to try inflation.

The big factor holding back economic growth in both the U.S. and Europe, the two economists say, is debt: Consumers, companies and governments are all struggling under the burden of huge debts run up during the boom years, making it harder for them to spend, borrow and invest.

That diagnosis of the problem — they cite “This Time Is Different,” Carmen Reinhart and Kenneth Rogoff’s now-famous study of financial crises — is fairly mainstream at this point. But their prescription isn’t: Ease the burden on debtors by allowing inflation to rise.

“Raising the expected rate of inflation would reduce the real burden of debt on households, corporations and governments, spurring both investment and consumption,” Profs. Chinn and Frieden write, arguing the Fed should allow inflation to run “in the 4 to 6 percent range for several years.”

The authors recognize their proposal will likely be “met with howls of indignation” from creditors, who would see a policy of intentional inflation — which would reduce the value of their bonds — as an expropriation of their assets. “To an extent, they are right,” the economists say.

But one way or another, they continue, those debts aren’t going to be repaid in full, whether it’s through inflation, default, bankruptcy or negotiated settlements. Better to do it in a way that’s quick and, because it treats all debts equally, at least relatively fair. The logic is the same as in bankruptcy proceedings, they write: “For creditors, something is better than nothing; for debtors, relief is better than default; for both, certainty is better than uncertainty.”

Messrs. Chinn and Frieden join other prominent economists, including Mr. Rogoff and left-leaning economists such as Paul Krugman, in arguing for more inflation. But one important economist they don’t look likely to win over: Mr. Bernanke. In this week’s testimony, Mr. Bernanke left little doubt that he opposes raising the inflation target, even temporarily. (Mr. Bernanke has plenty of prominent backers for his position, too, including former chairman Paul Volcker.)
…

View the original article here