In a post entitled Fear of inflation, Char Weise wrote:
The WSJ blog reports that companies are worried that inflation will rise in coming years...
Of course, raising inflation expectations is precisely the point (or should be, if the Fed is doing its job properly) of the Fed's program of quantitative easing...
[T]he fact that the businesses that were surveyed believe inflation will be higher than the Fed's target 5-10 years from now is an indication that the Fed's statements about its inflation target are not credible. And this lack of credibility should actually be helping to stimulate the economy.
Okay, I accept all that. But then Char says
[I]t would be preferable if the Fed were to loudly proclaim that yes, it does intend to let inflation rise above 2 percent in the future.
Char wants inflation.
I want to know at what moment it was that the inflation problem was magically transformed into the inflation solution. I responded to Char's post:
But are economists not embarrassed and ashamed to call for inflation?
Defending economists, Char said
I'm not ashamed to call for more inflation. Higher expected inflation would lower real interest rates and help get us out of the recession. An inflation rate of 3-4% would not have significant harmful economic effects relative to the current 2%.
No significant harmful effects? Depends who you ask, probably. I let that go.
I understand that.... But I think the problem is excessive private debt, not excessively stable prices.
Defending a principle, farm land investment said:
[T]he private sector absolutely must deleverage. However, isn't it also true that a bit of inflation above trend would lessen the real value of these debts and contribute to the private sector deleveraging process, essentially helping to "inflate debt away"?
It's funny, you know? Change the phrasing a little bit, and it makes you think. "A bit of inflation above trend," FarmLand said.
I think FarmLand was talking about the inflation trend. But I think for his plan to work, for inflation to inflate debt away, inflation has to be above the trend of debt growth. Otherwise prices increase but debt increases faster, and we get further behind.
I pointed this out in the Microbes post:
Debt relative to income is high. Sumner says we can solve the problem by increasing income via inflation. Did that work, say, in the 1970s?
Maybe it did work for the latter half of the 1960s. Inflation pushed NGDP up, and at the same time inflation reduced the burden of existing debt: Inflation increased Sumner's denominator and decreased his numerator simultaneously. And all it took was a 23% increase in prices in the five years between 1965 and 1970. Meanwhile, total debt increased 44.6%, almost twice the rate that prices went up.
Prices couldn't go up fast enough to keep up with the growth of debt. After 1970, inflation got worse, but Sumner's "debt to income" ratio WENT UP ANYWAY.
As long as debt continues to increase, inflation cannot solve the problem of excessive debt.
And I pointed it out in Dancing with Steve:
Keen still fails to see the cost of debt in general as a cost issue for the economy. A factor cost issue.
I quoted Steve Keen:
[W]hen debt rises faster than income, and finances not just investment but also speculation on asset prices, the virtuous cycle gives way to a vicious positive feedback process...
debt ALWAYS "rises faster than income" -- except at the end
and I showed this graph:
|Graph #1: Total Debt relative to GDP (GDP is Income!)|
Debt ALWAYS rises faster than income, except at the end.
Jazzbumpa disagreed with that, of course:
Have another look at Fig. 1 of the current post; no growth from 1960 through the mid 70's. Very little growth over the first three decades shown.
And where is the break point? right after 1980. Hmmmmm.
Jazz sees everything in terms of 1980. Sure, debt increased faster after 1980. Sure, the uptrend was gentle before 1980. But still it went up!
If you look at that first half of the graph, debt increased more before 1965 than after. After 1965, we had the "Great Inflation" which (as farm land investment suggests) helped to reduce the burden of debt by inflating it away.
Still, between 1950 and 1980, debt increased substantially as a multiple of GDP:
|Graph #2: Total Debt relative to GDP, through 1982|
Between 1965 and 1980, despite accelerating inflation, debt increased relative to GDP.
Invert that ratio and take another look. On the graph below, the blue line shows GDP relative to total debt. See if you can find the spot where inflation reduced debt enough to let the blue line show an up-trend:
|Graph #3: GDP relative to Total Debt, and Prices|
Oooh! There it is! From 1965 to 1970, the blue line goes up.
The green line shows the price level as measured by the CPI. The red line shows the price level as measured by the GDP deflator. Both measures show a slight, straight-line uptrend to about 1965, then definitely rounded upward curves as inflation accelerated from 1965 to 1980, and then continued inflation after 1980 but again as straight-line uptrends.
Focus on the years from 1965 to 1980, when inflation was raging. To see how inflation affected debt and income, look at the blue line.
A reminder: GDP is "output" but it is also a measure of "income" because transactions are two-sided. When somebody buys some of the output, somebody receives income. The one number is recorded in two places: as income, and as output.
The blue line shows output (or, income) relative to total credit market debt owed. The general trend is downward, meaning that output (or, income) grew more slowly than total debt. The steeper the downtrend, the more slowly output increased. The flatter the blue line, the closer output growth was to debt growth.
Between 1965 and 1970, the blue line actually trends upward. For those few years, income grew faster than debt.
For the rest of the years of the Great Inflation, 1970 to 1980 or '84 maybe, the blue line trends down again -- slowly at first, then faster as time goes by. As inflation got worse during the 1970s, the plan to inflate debt away proved itself to be more and more a failure.
Why? Because -- as Char says -- inflation stimulates spending. And since we use credit for money, when we spend more we create more debt. And if debt hinders economic growth (which it most certainly does), then creating more debt slows the growth of GDP and pushes the blue line down.
You cannot reduce debt by controlling only one variable unless that variable is debt.
If you control only income, and you inflate income, and you do not stop the commensurate increase of debt, you have done nothing to reduce debt relative to income: You have done nothing to solve the debt problem.
Debt increases more quickly than prices:
|Graph #4: Total Debt and the CPI|
Debt always increases more quickly than prices, except during severe recession:
|Graph #5: Total Debt relative to the CPI|
We cannot inflate debt away. In order to solve the debt problem we must deal with debt directly.