Friday, April 6, 2012

Why Economists are Rooting for Inflation

In most people’s minds inflation is up there with unemployment as one of the main ills you don’t want an economy to come down with. But in fact a growing number of economists are arguing that rising prices are exactly what we need to cure our the current economic maladies. It may not be the best answer, but it could be the easiest one to achieve.

The latest economists to get on the inflation bandwagon are Menzie Chinn of the University of Wisconsin-Madison and Jeffry Frieden, who teaches international monetary policy at Harvard. The two professors, who wrote a book about the financial crisis called Lost Decades that was published in September, and who recently penned an article for Foreign Policy magazine, argue that the reason recoveries after financial crises are painfully slow is that credit shocks stymie everyone. Banks stop making loans in order to heal. Consumers use extra cash to pay down debts. And governments lapse into gridlock as politicians argue over who should take the hit for their countries’ debts: taxpayers, government workers or the poor. But Chinn and Frieden argue there is a way to heal banks, borrowers and the government at the same time: Higher prices.

The argument for inflation is two-fold. One, inflation would shrink the value of the debts both the government and borrowers have to pay, improving our collective balance sheets. Higher salaries would also make it easier for borrowers to pay back their loans helping banks. Two, and this might be the more important reason now, inflation pushes people and companies to spend money. If you know prices are going to drop or stay flat, then you will delay a purchase. That’s why most of us are late adopters when it comes to technology. But if you know prices are going to rise, then you will spend your money now. So increasing inflation could stimulate the economy, as well as lower our debts. Read more.......

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