The Case for Inflation; or, The End of Orthodoxy

I attended a symposium this morning on America's Debt Overhang, hosted by the non-partisan New America Foundation (NAF). There were several interesting discussions about the present and future implications of America's ballooning public, private and household debts. I will return to these debates in greater detail tomorrow.

One presentation in particular stood out: Christopher Hayes, a fellow at NAF, presented a controversial paper entitled Overcoming America's Debt Overhang: The Case for Inflation.

Hayes argues that America's debt burden has become crippling. Indeed, household debt has risen from 48 percent of GDP in 1981 to 97 percent today. Meanwhile, corporate debt has grown from 22 percent in 1981 to 120 percent in 2009. The federal government is borrowing and spending at unprecedented peacetime rates. This toxic cocktail may spiral out of control:

Even short of default, a vicious cycle can take hold. At a certain point households, firms, and even governments are forced to spend money on meeting short-term debt servicing obligations rather than on making long-term investments.  What results is a form of debt serfdom.  Farmers don't invest in new crops and land; businesses don't add needed productive capacity because every spare cent goes towards interest payments. Governments can't afford to provide basic services because they have to pay off onerous debts. Households can't send their children to college because credit card payments have eaten up their savings.

If we are to emerge from the current crisis into an economic future of sustained growth and widespread prosperity, we are going to have to do something to lessen the burden that past debts now impose on investors, innovators, consumers, and the federal government.  Failure to do so would likely lead to a Japanese-like lost decade of low or non-existent growth, or worse.

The surest way to avoid such a fate is to jettison a central, indeed the central axiom of post-1970s neoliberal global capitalism, and that is to embrace a period of moderate, sustained inflation. 

Wow! Keynes is alive and well!

Hayes suggests that the crisis hasn't been kind to economic orthodoxy, and that inflation hawks were responsible for throwing the Great Depression into a deeper plunge in 1937.  Hence, previous ideas over the perils of inflation may not apply to our current situation.

Most remarkable about Mr Hayes' presentation was how little opposition it faced from the other panelists and the audience. Most people seemed to nod in agreement. I suspect some of this acquiescence can be attributed to doubts about whether the Untied States economy, which is running far below its productive capacity, could achieve such inflation in the near term. Nevertheless, it appears that many economists and writers are not worried about a re-run of the 1970s.

Friedrich Hayek once quipped, "I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments."

While it is unclear whether or not a period of sustained inflation would benefit the American economy, it will certainly punish the prudent, whose savings will be inflated away, along with everyone else's debt.