The 2% solution

Neil Irwin is often good. But this post of his from 2014 disturbs me: Of Kiwis and Currencies: How a 2% Inflation Target Became Global Economic Gospel

How did the 2% inflation target become global economic gospel? Irwin answers that question in the first paragraph, using an interesting twist of language:

Sometimes, decisions that shape the world’s economic future are made with great pomp and gain widespread attention. Other times, they are made through a quick, unanimous vote by members of the New Zealand Parliament who were eager to get home for Christmas.

He completes his answer in the second paragraph:

The practice was so successful in making the high inflation of the 1970s and ’80s a thing of the past that all of the world’s most advanced nations have emulated it in one form or another.

So the 2% policy was created by accident, by politicians less interested in governing than in getting home for the holidays. And 2% policy became the standard by dumb luck: It seemed to work, and everyone got on board.

This is not really good analysis on Irwin's part. He dumps on government, and everybody likes that, so he has an "in" at the start. No doubt there is another side to the story, a more respectable, more respectful side, which Irwin does not cover. Not that there's an audience for that side of the story.

Having created the picture of a shoddy foundation for 2% policy, Irwin proceeds to poke and prod us toward thinking that 2% is no good:

Yet even as the idea of a 2 percent target has become the orthodoxy, a worrying possibility is becoming clear: What if it’s wrong? What if it is one of the reasons that the global economy has been locked in five years of slow growth?

Note that his attack on 2% policy is based solely on "what if".

And again:

All of this has quite a few smart economists wondering whether the central bankers got the target number wrong. If they had set it a bit higher, perhaps at 3 or 4 percent, they might have been better able to combat the Great Recession...

What if they had set a higher target.

And again:

“Probably in the abstract had they settled on a somewhat bigger number, that would have been a better choice,” Mr. Blinder said.

That's "what if" in economist-speak.


By now I've criticized Neil Irwin's attack on 2% policy as baseless, and criticized his presentation of the higher-target argument as empty. So maybe you are thinking that I support the 2% policy. I don't. I'm not defending 2%. I'm criticizing Irwin's analysis.

For the record, I don't support 2% inflation. I support zero inflation. But not now, and not as a solution to anything.

Inflation is the economy's way of telling us that it has a problem: Inflation is the economy's way of fixing the problem. When we figure out what the problem is, and fix it, inflation goes away. That's why I favor zero inflation. Because it will be a sign that we fixed the problem.

Now you're mouthing the words "printing money causes inflation" and you think that I think that printing less money will get us to zero inflation. That's not it. Not even close. I did say "When we figure out what the problem is", remember?

To tie off this tangent, let me say what I think the problem is. We use money for money. And we use credit for money. But sometimes we use more money and less credit, and sometimes we use less money and more credit. And by "sometimes" I don't mean Tuesday versus Saturday. I mean, for example, the 1950s and '60s versus the 1990s and 2000s and since. The problem that our economy has is that we use too much credit for money, and not enough money for money. There is an imbalance between money and credit, an excess of credit use, an excess of debt.

There is an excess of private sector debt. This creates problems, in response to which public debt has increased. Almost everyone sees and objects to the increase in public debt. Few see and object to the high level of private debt that created the problems and caused the public debt to grow. Those who do point to private debt as the problem seem universally to point to faster increase in public debt as the solution. But that solution is not quite right.

There is an imbalance between money and credit. There is much credit, relative to money. If we say private debt is a measure of credit, and public debt is a measure of money, then there is too much private debt relative to public debt. This is the imbalance, the monetary imbalance that creates our economic troubles.

Those who call for greater increase in public debt are right in the sense that increasing the public debt reduces the monetary imbalance. But the analysis must not stop there. For in our economy, increases in the public debt lead to greater increases in private debt. This makes the imbalance worse. So the solution, as I see it, is not to focus on increasing the public debt, but to focus on limiting the increase of private debt.

That's not really as bad as it sounds, for we can limit the increase of private debt easily, by encouraging faster repayment of that debt. Policy-makers think credit is good for growth, and they make lots of policies that encourage the use of credit. As a result, our use of credit has increased. But policy-makers have not also created policies that encourage the repayment of debt. So our accelerated use of credit makes private debt grow at an accelerated rate, and no policy does anything to reduce the growth of private debt. This is where policy must be corrected.

So you can see that the optimum rate of inflation is not my main focus. Maybe you can also see that in my view, the 2% inflation target is most definitely not "one of the reasons that the global economy has been locked in five years of slow growth". And that a higher inflation target will not solve the problem.


I'm criticizing Irwin's analysis.

The argument about whether we should double the target inflation rate from 2% to 4% is an argument between two factions unaware that the problem lies elsewhere. Neil Irwin refers to the doubling as setting the target rate "a bit higher", and he quotes Alan Blinder calling 4 "somewhat bigger" than 2. But these misrepresentations do not disprove that 4 is twice as much as 2.

Irwin quotes Laurence Ball saying “Any adverse effects on the economy of having 4 percent rather than 2 percent inflation are trivial compared to the effects of having a horrible recession like we’ve been experiencing.”

Trivial? To whom? To the 99%, yes. To the 1%, no. To the 1%, seeing the value of their money halved in a generation must be no trivial matter. It's hard to sympathize with the 1%, I know. Still, they have the money, and the power that goes with it. So if you want to fix the economy, you'll have to do it in a way they can live with. Doubling the rate of inflation is not it.