February 27, 2021

High & Low Finance: Sometimes, Inflation Is Not Evil

Thirty years ago, it became clear that defeating inflation was crucial, even if the means needed to accomplish that would cause a deep recession. By the time the European Central Bank was created in the 1990s, it seemed so obvious that inflation must be fought that the bank was given only one mandate — to fight inflation. The other mandate given to its United States counterpart, the Federal Reserve — to promote employment — was pointedly not included.

It is time for a new lesson to be learned. Sometimes we need inflation, and now is such a time.

Had the central bankers of the world understood that inflation in asset prices could be just as bad as, if not worse than, inflation in the prices of consumer goods, this would not be necessary. But they did not. So they did nothing to resist soaring home prices, just as they had seen no reason to worry about the Internet stock bubble.

When pressed, they would say they knew what to do if an asset bubble did burst — ease monetary policy. That seemed to work after the Internet bubble burst, and the ensuing recession was a mild one that did little damage to anyone except foolish investors. But the strategy only worsened the housing bubble and has not done much to revive the debt-choked economy over the last two years.

In 2008, when the credit crisis brought the world economy to a screeching halt, governments and central banks stepped in to bail out large financial firms on the theory that a decently functioning financial system was a prerequisite to economic recovery.

That analysis was correct, but there were at least two problems with the fix:

First, at least some banks were not really made healthy again. That was especially true in Europe, where recapitalization of banks proceeded slowly. They were thus vulnerable to a new round of credit worries, this one based on sovereign debt issues.

Second, this country is full of people whose homes are worth less than they owe. That provides threats to the lenders and to the borrowers. Those borrowers need debt relief, but there are many issues that have prevented any real action.

Simply put, you can’t operate an economy where huge numbers of people are desperately in debt and have no real way out. We need to either find a way to reduce what they owe or to raise the value of the homes securing the loans, or some of both.

In a column in The Financial Times this week, Ken Rogoff, the Harvard economist, suggested central bankers consider “the option of trying to achieve some modest deleveraging through moderate inflation of, say, 4 to 6 percent for several years.”

Mr. Rogoff conceded that “any inflation above 2 percent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s.”

He was right about that.

“I don’t think it’s a good idea,” was one of the milder comments I got from the most celebrated veteran of those wars, Paul A. Volcker, the former Fed chairman.

And anyway, he added, “Right now they probably could not get inflation if they wanted to.” People are not spending the money they have, he said, adding that the situation reminded him of an era he studied in college — the Great Depression.

In an interview, Mr. Rogoff recalled how a parade of economists suggested to Japan that it seek to raise inflation to an announced target after its bubble burst, how Japan did nothing of the kind, and how it never really recovered. The Fed, he said, could make clear that it wanted some inflation and would buy Treasuries until it got that result.

“It has to be open-ended,” he said of such a program, not limited to a certain dollar amount of bond purchases, and it needs to be connected to a stated inflation target. The Fed chairman, he said, could say that “If and when inflation starts rising above the path I am aiming for, we will taper back bond purchases and raise interest rates to rein it back in.”

As it is, millions of mortgage loans secured by homes are worth far less than the loan amount. That keeps people from moving in search of better opportunities, and it removes an incentive for maintenance spending to preserve the value of the home. Many of those loans will never be paid in full, but there seems to be no route to a quick resolution.

Article source: http://feeds.nytimes.com/click.phdo?i=ff8518a4a1c6f8e3f23c825c681ef83a

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