The Inflation solution : Unanticipated inflation

The inflation Solution (The Economist March 13^th 2010)

 

The higher inflation rates required in normal times would create the space for bigger cuts during slumps.

 

1. The higher inflation greases the wheels of the economy.
   
   1. Regain competitiveness through wage adjustment.
      
   2. Eroding real value of mortgage.
      
2. Worry about inflation; practically inflation is hard to achieve; benefits may not be quite as obvious
   
   1. America's reduced burden of debt not only comes from inflation but also from GDP growth and budget surplus.
      
   2. All of these inflation tax was borne by those who hold bonds with a maturity of five years or more.
      
      1. In 1940s, average maturity of federal debt was more than 7 years.
         
      2. Today, the weighted average maturity of all American public debt is around 5 years.
         
      3. Government have an incentive to keep inflation rate low to issue new bonds to cover huge budget deficit.
         
   3. Political hurdle.
      
      1. Alongside a rapid build-up of debt by some households there has been an increase in cash deposits by others.
         
      2. Using inflation to transfer wealth from savers to debtors may help boost spending. But there are limits to how much you can do this in a country such as Britain, where both savings and mortgages linked to short term interest rates.
         
      3. Inflation would over time reduce the real burden of debt but would raise interest costs more quickly. Nor would it be politically popular: savers tend to be older and the old vote more often.
         
3. A burst of unanticipated inflation that was not expected to last would be a salve to the most troubled rich economists, but it is not something that can be easily engineered.
   

 

Best Policy may well be to talk tough about inflation while keeping interest low for as long as possible.