David Blanchflower has once again suggested that we would not need to worry about austerity if only we allowed price inflation of 5% for a few years. Let us ignore the moral issues of whether there is an optimal extent to which we can rob people of their savings in the name of economic growth. Let us also ignore the fact the the problems with the lack of economic growth are as much supply side problems as anything else. As I explained onConservativeHome a couple of weeks ago, the professor’s arithmetic does not even add up.

One fifth of government debt is index-linked. Index-linked debt cannot be inflated away. 35% of the government’s debt is made up of Treasury Bills, short-dated debt or ultra short-dated debt. There is little that the government can do to inflate this away. This will have to be refinanced within the next seven years (most of it much sooner) and, as inflation expectations will rise if the central bank pursues an explicitly inflationary policy, the cost of refinancing this debt will increase. Over the next five years, the UK government is also planning to borrow an amount not much less than the existing national debt in nominal terms. None of this can be inflated away: it will all have to be financed in the new environment of higher inflation if the Keynesians have their way. So what is the bottom line?

The only debt that can be inflated away with any significant effect is the existing long-dated or medium-dated conventional government debt that has already been issued. This is the debt which the government has promised to service with fixed (not inflation-linked) interest and capital payments. This is currently 43% of the existing national debt, but it makes up only about 20% of the debt that will exist by the end of the proposed policy of creating inflation. If inflation were 5% for a few years, as suggested by Professor Blanchflower, the real value of this debt might fall by about 2%-5% of the total projected debt in 2016: this is a drop in the ocean. This “gain” could easily be cancelled out by a higher inflation risk premium that would be demanded by investors on newly issued government debt.


Read the full original article on ConservativeHome.

Philip Booth 154x154
Philip Booth is Academic and Research Director at the Institute of Economic Affairs and Professor of Finance, Public Policy and Ethics at St. Mary's University, Twickenham. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. Previously, Philip Booth worked for the Bank of England as an advisor on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs and on the editorial boards of various other academic journals. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

3 thoughts on “Blanchflower has an inflated view of the powers of central banks”

  1. Posted 18/11/2010 at 11:17 | Permalink

    Actually, let’s not ignore the moral issue – an inflation rate of 5% will decimate those of us attempting to be prudent by putting money on one side, halving our capital in 10 yrs; once this has been done, the state will then have to support an ageing population which is increasingly impoverished, thus reducing consumption – which is what Blanchflower is seeking to stimulate with his Keynsian proposals. He used to be respected for his willingness to go against the flow at the MPC as the economy wobbled, but he has squandered that respect by refusing to change as circumstances change. I think the moral issue is as important as the technical ones outlined above.

  2. Posted 18/11/2010 at 11:35 | Permalink

    I wonder if Professor Blanchflower also (or instead) has in mind the old Keynesian trick of ‘fooling the workers’ into accepting a real cut in their wage-rates by maintaining the nominal rates of pay while reducing the purchasing power of money.

    In chapter XIX of The General Theory, Keynes argued that a ‘flexible money policy’ (i.e. inflation) was preferable to a ‘flexible wage policy’. He seemed to think that ‘uniform’ wage reductions might be desirable (as opposed to changes in relative wage-rates).

    Admittedly Keynes did also advocate currency debasement as a means of decreasing the ‘excessive burden of many kinds of debt’. Maybe not everyone got as far as chapter XIX?

  3. Posted 18/11/2010 at 13:17 | Permalink

    You underestimate the power of central banks.

    Imagine what you could do if you had a licence to print money at will.

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