Deflation in a time of excessive debt is the worst possible solution, because debt does not deflate with income.
Inflation in a time of excessive debt reduces the debt problem, because debt does not inflate with income.
The notion that inflation can be used to solve our debt problem is a tempting one. But it depends on our ability to increase the quantity of money without increasing the accumulation of debt. If debt grows as fast as money or faster, the debt problem is not resolved. Capiche?
Our most significant inflation occurred between 1965 and the early 1980s, as the blue line shows:
The red line shows that total debt increased continuously relative to money, during that period. In other words, debt grew so fast in those years that the debt-per-dollar ratio was not reduced, despite the printing of money enough to cause all that inflation. The imbalance between money and debt was not corrected, despite all that inflation.
Suppose we look at it another way: The existing accumulation of debt becomes easier to bear after a period of inflation. That is Paul Krugman's argument, right?
Here's my argument: The accumulation of debt becomes easier to bear after inflation, if and only if the accumulation of debt does not grow faster than prices go up.
The increase of prices is given by the Consumer Price Index. If I divide total debt by the CPI and the trend line goes down, then debt grew more slowly than prices went up, and inflation solved the problem. But if the trend line goes up, then debt grew more rapidly than prices went up, and inflation did not solve the problem.
Even during the inflation of the 1970s, total debt increased more quickly than prices went up. Inflation did not solve the debt problem. Krugman's solution was tried, and failed, in the 1970s.
Oh, but I have forgotten to allow for the increase of real output. Very well then: Let us look at total debt relative to nominal GDP, so that we allow for both real growth and price inflation at the same time. If the trend-line continues to increase during the inflationary period, then again we must say that Krugman's solution has failed.
The rate of increase was noticeable slow in the 1965-1980 period, but the trend line continues upward. Debt increased faster that real output and the price level combined. In other words, the inflation of those years did not reduce the burden of debt in our economy.
But we didn't really need to look at another graph to know it. We knew it already, because the 1970s were sluggish, not golden, and the 1980s were not much better.
2 comments:
I'm very happy to see your last graph, since I was thinking you were missing the output component.
Zero in on the period 1960 to about 1975. The line is dead flat, plus or minus a few wiggles. It's not until after 1975 the the line curves up even a little, and not until after 1985 that anything dramatic happens.
So your statement that Krugman's (presumably Keynesian) solution was tried and failed really doesn't hold up.
As I pointed out here using Mike Kimels graph, 1975 is as good an inflection point as any for the shift from Keynesian to non-Keynsian policies.
Also note in your first graph, that the debt ratio continues on its merry exponential way long after the CPI increase takes a major nose dive. What do you make of that?
I not disagreeing with you in a major way, but I think your analysis focuses too much on what you want to find, and doesn't give enough consideration to other things.
Also, there is the ratio trap that I (and Krugman) warn people about. You've looked a lot at the numerator of Deb/GDP. I've looked a lot at the denominator.
As my posts the other day showed, GDP growth was much higher in the 60's and 70's then any time since. Growing numerator/slower growing denominator = rising function.
That part of your argument might not be much more than a tautology.
And uses of debt matter. Debt of the finance sector has ballooned over the period, while real investment debt has not. This gives a clue as to how these things influence each other. Investment debt goes to build GDP. Finance debt is non-productive, and gets devoted to bubble creation.
All of this is aided and abetted by income and wealth disparity, and I believe that is the real source of the problem. Root causes are in tax policy, declining income share going to labor, and deregulation.
All of these things changed in the 70's.
There is your debt explosion.
Cheers!
JzB
Jazz, this is (as you know) an important topic for me. I appreciate your attention to my details.
Zero in on the period 1960 to about 1975. The line is dead flat...
But the line does not fall. There was no reduction in the burden of debt. We were only treading water. Despite much more inflation than Krugman says we need to solve the problem now.
A flat spot isn't enough. We need to drive debt down. Look at the last couple years of the debt/gdp graph: the reduction of debt is obvious. There is nothing like that in the 15 years you bracket. Treading water doesn't get the job done.
Again: If we go with inflation as a way to reduce the debt burden, then we need to increase money (or whatever it is that causes inflation) faster than debt increases. But in our economy, our way of controlling money has been reduced to controlling the expansion of credit use. Our approach to policy guarantees failure of the inflation plan to reduce debt.
And with unemployment so high, wages refuse to rise. So what sounds like pro-inflation policy is really just a way to drive up the cost of living.
Also note in your first graph, that the debt ratio continues on its merry exponential way long after the CPI increase takes a major nose dive. What do you make of that?
Striking, isn't it. Suppression of demand, perhaps? (The supply-side approach.)
I not disagreeing with you in a major way, but I think your analysis focuses too much on what you want to find, and doesn't give enough consideration to other things.
Yeah, I see everything through this lens. No doubt about it.
That part of your argument might not be much more than a tautology.
I look at it three different ways in the post, and "per GDP" is only one of them.
Uses of debt DO matter. But despite 30+ years of focus on the supply side, the excessiveness of debt continues to dominate everything.
All of this is aided and abetted by income and wealth disparity, and I believe that is the real source of the problem. Root causes are in tax policy, declining income share going to labor, and deregulation.
Aided and abetted, yes absolutely.
"Real source"... I go with the excessiveness of debt, which precedes the increase in disparity. Disparity, tax policy, and deregulation were solutions applied (mostly since 1980) to try to solve the problem of inadequate growth, which was obvious in the 1970s.
I put the decline of growth earlier than you do... with the 1974 recession.
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