Reduction (3)

From this morning's post:

The problem is not that we have inflation. The problem is not that economic growth is weak. The problem is that we need an inflationary increase in the money in order to get decent growth. Since we have chosen to keep inflation at a low level, we are limited to a low level of economic growth. This problem cannot be solved by thinking of inflation and growth as two separate problems.

The solution we applied since the 1980s included a great increase our reliance on credit, as evidenced by the growth of public and private debt.

The great irony is, the cost of existing debt was the source of the problem in the first place. Our solution only made the problem worse.

The great mistake is, we failed to use accelerated repayment of debt to fight inflation.

Reduction (2)

THIS POST IS BASED ON MINE OF 20 MAY PAST.

I don't dispute the quantity theory of money. I take it as a "given." But suppose something weird happened: Suppose it came about that we needed 3% annual money growth to keep prices stable, but we needed 6% money growth to keep the economy growing at a satisfactory rate. This would be a problem.

It would be a problem because the money growth required to keep the economy growing would be too much to assure price stability. It would be a problem because reducing money-growth enough to assure price stability would undermine growth. It would mean that we couldn't have growth without inflation, and we couldn't reduce inflation without reducing growth.

This is not a problem that would be. It is exactly the problem that we have had since the 1970s. Because of this problem, we cannot get growth enough to balance the budget. We can't get growth enough to keep unemployment low. We can't get growth enough to keep living standards rising. We can't get growth enough, period.

And still we've had inflation -- too much inflation, for too many years.

Worst of all, we cannot solve the problem. The problem arose in the 1970s. This is 2010, and we still have not solved the problem. And now on top of it we have financial crisis: Out of the frying pan, into the fire.

The problem is not that we have inflation. The problem is not that economic growth is weak. The problem is that we need an inflationary increase in the money in order to get decent growth. Since we have chosen to keep inflation at a low level, we are limited to a low level of economic growth. This problem cannot be solved by thinking of inflation and growth as two separate problems.

Q: What is it that might inhibit growth, except in conditions of high inflation?

A: Cost. Rising costs inhibit growth. Rising costs, for consumers, mean pay hikes are necessary or, barring that, living standards must fall. Rising costs for businesses mean prices must go up, profits are squeezed, and business is not good.

Cost is the problem that inhibits growth. But as it turns out, creating some inflation compensates for rising costs, and gets us a little growth. So policymakers have opted for low but continuous inflation.

Cost is the problem that inhibits growth and demands inflation.

Costs are rising. We knew this in the 1970s. Back then, people said there was "a wage-price spiral." Basically, policymakers and the media said prices were going up because wages were going up. So it was our fault. That was nonsense. Still, the problem is that costs are rising.

Q: If not wages, then what is the problematic cost?

A: You know the answer to this. Simon Johnson has pointed it out. ContraHour has pointed it out. Probably many others as well. Finance is the problem.

The excessive growth of finance is the problem. But of course, finance fills a need. So then, we may say the excessive reliance on credit is the problem.

Now it sounds like our fault again. We did the borrowing. For that matter, we did the lending, too. There is too much borrowing and lending, too much reliance on credit, too much cost of credit use. This is the cost that created our economic problems in the 1970s. And since that time, finance has only grown.

If I have said this well, there is only one loose end. Your question must be --

Q: Why is our reliance on credit so high?

A: Policy.

Reduction

If I've learned one thing from my time at computer programming, it's that to solve a problem, you break it into smaller problems and solve the smaller problems. It's a rule I rely on. But it is not infallible.

After the death of Keynesian economics, the reduction of the economic problem into smaller, more manageable problems caused incorrect solutions to be developed.

From mine of 5 July:

The shift from Keynesian economics to Reaganomics was an attempt to fix a problem. That problem was slow growth. (The problem was that we could grow faster only by accepting more inflation. Since we (reasonably) rejected that alternative, the problem was reduced to "slow growth." But perhaps this reduction muddied the analysis from which the solution emerged.)

We didn't have a problem making the economy grow. The problem we had was that we were getting inflation along with growth. When we stamped out inflation, we lost the growth. When growth came back, inflation came back. It was the Seventies.

Reduction of the problem encouraged us to think of inflation and slow growth as two separate problems, to be dealt with separately. But there were not two separate problems. We did not have a problem getting the economy to grow. We did not have a problem keeping inflation under control. We could do either one exceptionally well.

The problem that caused the death of Keynesian economics and gave birth to Reaganomics was not an "either/or" problem. The problem was that we couldn't get healthy growth and price stability at the same time. Splitting the problem into two smaller problems was not a reasonable approach, because it was the combination that was the problem.

At the time, people did not understand that the combination was the problem. People still don't understand it today. Let me give you one example. Paul Krugman writes:

Here’s what I think: inflation did have to be brought down — and Paul Volcker, not Reagan, did what was necessary. But the rest — slashing taxes on the rich, breaking the unions, letting inflation erode the minimum wage — wasn’t necessary at all.

Paul Krugman in 2010 -- May 24, 2010 -- still separates the monetary policy from "the rest" of policy. Still separates anti-inflation policy from pro-growth policy. Still sees the separate application of these two policy tools as the right way to approach the economic problem.

We still have not solved this problem, which emerged in the 1970s, because we still think of it as two separate problems. But it is not two separate problems. It is one problem. The problem is that we can't get healthy growth and price stability at the same time.