The economy is still limping, job losses are still rising, and consumers are still reluctant to open their wallets. So it’s the perfect time to worry about . . . inflation? Apparently so, because, of late, the cries of inflation hawks have grown increasingly loud. Pointing to huge deficit spending, and to the flood of money that the Federal Reserve has sluiced into the economy, they argue that we’re at serious risk of “igniting out-of-control inflation” and bringing about the collapse of the dollar. Unless the Fed starts slowing things down, they say, we’ll face price jumps that qualify as “hyperinflationary” (a word that Senator Charles Grassley, the Iowa Republican, actually used the other week). Most Americans are worrying about keeping their jobs. Now we have to worry about becoming Zimbabwe, too.
Of course, you can’t see any of this inflation in the numbers. The Consumer Price Index fell in July, and, over the past year, prices have actually dropped two per cent. And there’s not much sign that inflation is coming down the pike; the price of U.S. inflation-indexed bonds suggests that investors think future inflation will stay low, perhaps around two per cent. So do the remarkably low interest rates on government debt; the U.S. wouldn’t be able to borrow money for ten years at less than four per cent if people thought that double-digit inflation was in the offing.
To be sure, both deficit spending and the Fed’s recent measures could, in theory, create inflationary pressure. But they haven’t, because they’ve just gone to counteract the sharp decline in consumer and business activity. The government is borrowing more, but consumers and businesses are borrowing less. As for the money the Fed has been pumping through the banks, much of it hasn’t actually made it into the economy; banks are keeping hundreds of billions of dollars in reserves on hand. If the definition of inflation is too many dollars chasing too few goods, the too many dollars aren’t out there. In the real economy, meanwhile, worker productivity is tremendously high; wage growth is stagnant; and there’s still an enormous amount of slack—capacity that’s not being used and people who don’t have jobs. All of these things will put a lid on price pressures for some time to come.
Then why are people afraid that inflation is about to get out of control? Because they’re always afraid that inflation is about to get out of control. Indeed, many of those arguing today that the Fed should place the threat of inflation front and center were saying the exact same thing last year—in the middle of a recession. To be fair, last year there actually was inflation, thanks mainly to skyrocketing commodity prices (notably, oil and food). But the core inflation rate remained relatively low, and throughout the spring and summer of 2008 the U.S. economy was losing hundreds of thousands of jobs a month, while consumers were cutting back on spending and banks on lending. Yet inflation hawks inside and outside the Fed insisted that inflation was as much a danger as recession, and called on the Fed to raise interest rates—generally not what you want to do when the economy is tanking. All this clamor had an effect: between April and October of 2008, while the recession deepened, the Fed failed to cut interest rates, and rumors about the possibility of interest-rate hikes made businesses more cautious and encouraged consumers to hunker down and hold on to their cash. And the Fed wasn’t even the worst offender in this regard—the European Central Bank raised interest rates in July, 2008, just as the world economic meltdown was beginning.
Of course, looking tough on inflation is part of any central banker’s job description: if investors believe that inflation is going to get out of control, you end up with higher interest rates and capital flight, and a vicious circle quickly ensues. Nonetheless, there’s something peculiar about how powerful fears of inflation are. In the past ninety years, the U.S. has had only one sustained bout with high inflation—in the seventies. That track record should engender some faith that central bankers are going to be responsible, and that a healthy industrial economy isn’t prone to regular inflationary spirals. It hasn’t. Instead, we’re always about to relive 1974 all over again, which is why last year, as oil prices rose, we were bombarded with references to “stagflation.” In a way, there’s something profoundly puritanical, in the original sense of that word, about the inflation hawks: we are always on the verge of sinning, always about to succumb to our worst impulses. Even the rhetoric of inflation—the “debasement” of the currency—carries a moralistic tinge.
This isn’t to say that cheap money is always good—it has a nasty habit, for one thing, of starting asset bubbles. So, as Ben Bernanke, the Fed chairman, told Congress in July, once the economy starts growing again the Fed will have to start pulling money back out. But, in any balancing of the current threats to the economy, the danger of stagnation trumps the danger of inflation. Even if we are on the brink of recovery, the last thing we need is for the Fed or the federal government to start embracing a tight-money policy. To do so would risk a reprise of 1937, when, with the economy bouncing back from the depths of the Great Depression, the Fed tightened monetary policy and the government raised taxes, provoking a disastrous downturn that lasted until the Second World War. The Fed does have to make sure that the economy doesn’t go careering off the road. But let’s wait until the car is actually moving forward before we worry about applying the brakes.
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