Inflation must follow

The world is filled with irony and idiocies aplenty. For how many years was inflation targeting the very essence of economic policy when the threat of inflation was hardly anywhere to be seen. How many booms did high interest rates cut short and how much wealth did these policies kill off, all with the intention of preventing an inflationary spiral which was never going to happen?

Now with inflation a genuine concern, we find the International Monetary Fund suddenly thinking that perhaps inflation targeting isn’t such a good idea after all, that allowing a bit more room for prices to grow might not be such a bad thing.

Olivier Blanchard, the Chief Economist of the IMF, has just released a paper looking to reduce the role of inflation targeting in economic management, and has apparently suggested that inflation should be allowed to rise to four per cent to give governments greater scope to manage downturns.

According to news reports, “in a radical paper calling for far-reaching economic reform, the fund says too much reliance has been placed on interest rates to control the economy, and budget spending and direct regulation of banks should play a greater role.”

The theory behind inflation targeting, to the extent that there actually is a theory, argues that recessions are caused by inflation. Avoid inflation, it was said, and you avoid recession.

That inflation is not the only cause of recession ought to have been known to one and all, but for those whose history does not go back beyond the 1970s, it might have seemed plausible. There is no doubt that the 1970s were a period of rapid inflation coupled with high unemployment.

But it wasn’t the inflation that caused the unemployment; it was the combination of massively increased public spending, union militancy leading to a series of wage explosions, and huge increases in the price of oil. It was these that caused both unemployment and inflation to move beyond control and then continue for years on end.

So now we find the IMF apparently arguing that given the downturns we are all in, and the inflationary potential that the various stimulus packages have created, the answer is more inflation.

I have never been a fan of inflation targeting but inflation is about as bad an economic disease as one can find. Combining the useless unproductive public spending we have inflicted on ourselves already with a deliberate loosening of our inflationary restraints, which are not all that strong to begin with, will seriously undermine future rates of growth and reduce living standards for years to come.

There are still so many ways the current global financial crisis could morph into different and far more virulent forms of economic malaise. Allowing inflation to become entrenched once again would be one of the ways that the current downturn – which had it been handled properly from the start could have been over and done with in a couple of years – might yet remain with us well into the 2020s and even beyond. 

Bear in mind that the inflation that began in the late 1960s was not finally brought to an end until the early 1990s. This is surely not the kind of outcome anyone would like to see repeated once again.

1 thought on “Inflation must follow”

  1. Posted 23/02/2010 at 12:53 | Permalink

    The UK’s Retail Prices Index was rebased at 100 in January 1987 and reached 200 in September 2006. For prices to double in less than 20 years is hardly zero inflation. (In fact it is just under the 4.0 per cent a year that Oliver Blanchard is reported to have suggested.) Over a lifetime of 80 years it would mean prices multiplying sixteen-fold. Put another way, it would mean the purchasing power of money falling by over 93 per cent.

    This may suit those who owe money, as the ‘real’ value of their debts is reduced. Who is the largest debtor in the economy? Why, the government! What a coincidence.

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