June 08, 2002

Yet Another Sign of Worry That Inflation Is Too Low...

If someone with as long and distinguished a monetarist pedigree as Sam Brittan is worrying that inflation rates in the industrial core are too low, then such worry has definitely become part of the conventional wisdom.

A decade ago I argued that this was reason enough not to push the inflation rate below 4% per year. That argument still seems sound to me today.

Inflation can be too low - Samuel Brittan : Financial Times 06/06/02

Inflation can be too low

Samuel Brittan: Financial Times 06/06/02

Despite the apparent world economic upturn, excessively tight monetary targets could be dangerous if recession starts. The last International Monetary Fund World Economic Outlook contained a section entitled "Can inflation be too low?". The suggested answer was "Yes". Coming from an organisation regularly attacked as a pillar of western capitalist orthodoxy, the conclusion is pretty remarkable. It is also highly topical when so many central banks are pondering when to raise interest rates.

A serious difficulty about zero inflation is that it puts a floor under how far the real rate of interest - that is, the rate corrected for inflation - can fall. In the recession of the mid-1970s, triggered by the first oil price explosion, the world experienced double-digit inflation; and in many countries the real rate of interest was negative. This could well be one reason why the world did not experience more than a pause in the upward movement of output.

If, however, inflation is absent, nominal interest rates cannot fall below zero, where they have more or less been in Japan for several years. Moreover, most personal and many corporate borrowers have to pay a couple of percentage points above official interest rates. So if a near-zero base rate or prime rate is not enough to boost consumption or stimulate investment sufficiently in a recession, the economy will not easily recover...

Posted by DeLong at June 8, 2002 05:19 PM


In the past (ie the 70's) the presence of a genuine democracy in the US meant that inflation was broadly tolerated because it benefited the majority of the population paying debts.

It is not clear to me quite how inflation would play out in the new political environment controlled by the plutocracy. Obviously bondholders would hate it, but if they could hedge against it (particularly secure in knowledge conveyed by a nod and a wink from govt insiders that higher inflation was coming) they'd be happy. But who would be the patsies willing to buy these derivatives?

My point is that before reaching back to the 70's to think how things might play out, the new political environment needs to be considered. It might be interesting to learn how the rich in South America dealt with inflation.

Posted by: Maynard Handley on June 14, 2002 09:43 PM

By moving to Miami?


Brad DeLong

Posted by: Brad DeLong on June 15, 2002 04:35 PM
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