07 Apr 2012

Krugman Throws 99% Under the Bus on Inflation?

Economics, Federal Reserve, Inflation, Krugman 20 Comments

Uh oh, I know some of you don’t like it when I say this, but I think we have another Krugman Kontradiction on our hands… In his recent op ed calling for a moderate increase in inflation, Krugman writes:

[W]ould a rise in inflation to 3 percent or even 4 percent be a terrible thing? On the contrary, it would almost surely help the economy.

How so? For one thing, large parts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years; this debt burden is arguably the main thing holding private spending back and perpetuating the slump. Modest inflation would, however, reduce that overhang — by eroding the real value of that debt — and help promote the private-sector recovery we need.

OK, so let’s consider the perspective of the struggling middle- or lower-income household; the salt of the earth people for whom Krugman goes into battle every day against the buzzsaw of corporate blood money.

So you’ve got this household, where maybe the major breadwinner can’t find a good job to replace the one that was lost in 2009, and they’ve got credit card and medical bills piling up. Now gas is over $4 a gallon and they’re really feeling it. At this point, Krugman is saying that if prices on everything else they buy (not just groceries and energy) start rising at twice their current pace, the household is going to benefit?

Now I imagine the clarification would be: “Bob, Krugman is saying that a general depreciation of the dollar would help them. So no, it’s not that rising prices per se helps the household, but that with a general rise in prices, they can expect their wages to rise too. And so the $20,000 they owe the credit card companies isn’t as big a deal, if every price and wage in the economy goes up by 4%. It’s even more obvious if they have a fixed-rate mortgage, that a general rise in all dollar-prices, including wages and salaries, will help them. Thus, as more and more households find themselves getting breathing room from the real burden of their debt service falling, they begin spending more and that leads to a virtuous cycle of more aggregate demand, rising wages, and more spending.”

But wait a second: There is at least one economist I know who has been arguing quite forcefully for a few years now, that wages can’t rise quickly if we still have high unemployment. So I think on Krugman’s own terms, his solution of an increase in the rate of (price) inflation would mean, in practice, that the struggling households with the least bargaining power at their jobs would get absolutely crushed for a year or two by higher bills, and that their wages would only catch up once the economy was already fixed.

So it seems that the inflation approach sacrifices struggling households in order to give the 1% (who are fine and just sitting on hordes of cash balances) a reason to increase their investment and consumption spending. I’d call it Trickle Down if the name weren’t already taken.

20 Responses to “Krugman Throws 99% Under the Bus on Inflation?”

  1. Major_Freedom says:

    Another thing that fool doesn’t realize is that in our monetary system, money is created almost entirely as debt. Much of the money that is created by the Federal Reserve System leaves the banks as debt.

    Calling for inflation then, is actually a call for more debt.

    Sure, in theory the Treasury could spend more by borrowing more, after which the Fed monetizes the debt, thus bringing about inflation without debt, but then that would only encourage the creation of more debt. He seems to be holding debt constant, then imagining what happens with 3 or 4% price inflation, when in reality debt is both directly and indirectly tied up with inflation.

    • Bob Murphy says:

      Hmm interesting, MF. I never thought of that angle. You’re right, to a first approximation it’s a bit weird to recommend that the central bank inflate more, in order to reduce a debt overhang. Yeah, I guess he would come back and say it’s not just the overall level of debt that matters, but its composition–and that the Fed can inflate more, without households taking on more debt.

    • skylien says:

      I guess he is holding debt outside the FED constant. The FED doesn’t feel a debt overhang… So what he really wants is more direct monetization by the FED, but that is no secret, or is it? He calls for 8 to 10 Trillion in further QE.

      • skylien says:

        What I meant was that the Treasury doesn’t feel a debt overhang for debt that is held at the FED, since it gets most of the interest paid for this debt back from the FED..

        • Major_Freedom says:

          What will be interesting to see will be the political manoeuvring and strong arming that will inevitably arise once (if) the Fed reduces the rate at which it is inflating the currency (to avoid runaway consumer price inflation and missing their target), which will be accompanied by a rise in short term interest rates, which will result in the Treasury’s budget being composed to an even larger degree of interest on debt.

          It will be the Treasury wanting rates to stay low to prevent its budget being composed of more interest, and the Fed wanting to raise rates to prevent runaway inflation.

          I suspect that the banks will win. As part of this, US debt will probably become junk, as the only way the Treasury will be able to afford the interest would be to cut programs, sending the dependants into a state of shock from which it will take a long time for them to recover, or to monetize the debt even more, which will eventually wake the idiot creditors up to what has been going on already (61% of all government debt issued in the last year was monetized by the Fed!!!)

  2. rayray says:

    Where is the like button, on this machine?

  3. Daniel Kuehn says:

    Why do consumer prices increase one or two years before wages do? I don’t understand. Isn’t goods demand as slack as labor demand?

    • Daniel Hewitt says:

      Sticky wages?

    • Joseph Fetz says:

      I imagine it has to do with who receives the money and whether they are marginal buyers or not.

    • Joseph Fetz says:

      Actually, let me rephrase that. All marginal buyers who are receivers of the new money will tend to bid up the price of the good, whereas all sub-marginal buyers regardless of whether they are receivers of the new money or not, have absolutely no affect on prices. However, regarding labor, labor is performed before income is received, thus is based upon expected future income, not actual income. Remember, the structure of production takes time and labor is paid for well before the good is sold. However, in the goods market, the good is already available.

      • Joseph Fetz says:

        In other words, the price of one is based on discounted marginal productivity, whereas the price of the other is based upon present utility.

    • jjoxman says:

      Not demand for consumer goods.

    • Bob Murphy says:

      Daniel, in other contexts, when Krugman is explaining why we don’t need to fear runaway inflation, he says that in the current environment, with a big output gap and weak labor market, there is little upward pressure on wages. In fact, lately he has been surprised at how much wages have risen; he expected them to be flat.

      So then I’m saying that by his own worldview, if prices start rising across the board, average households are going to get hurt; their wages won’t rise in lockstep. Only when the economy is back to full employment will wages start rising in proportion to prices.

      Thus, Krugman is effectively solving the recession on the backs of the most vulnerable members of society, i.e. the exact thing he accuses Paul Ryan of.

      • Daniel Kuehn says:

        Right, but being below full employment says that demand is weak, doesn’t it? I.e. – demand for stuff, not labor. But that causes derived demand for labor to be weak. I guess I just don’t understand your sequencing here. Sure he’s said that as long as we’re in this situation price and wage inflation are going to be negligible. But in terms of exiting that situation, I don’t see why one of necessity leads the other.

      • Daniel Kuehn says:

        Happy Easter, btw

        Regardless of how certain we are of prices rising, we can be assured that He is Risen, right?

        yuk yuk yuk

    • Anonymous says:

      It’s because

      A. Wages are paid out of savings and capital, not consumer sales revenues; and

      B. Wages are an expenditure that shows up very quickly as costs as compared to capital goods expenditure.

      When a crash occurs, accumulated savings and capital collapses. There are two general types of business expenditure that restore profitability, wages and capital goods.

      Wage expenditures increasing will not restore profitability, because wage expenditures show up almost immediately as costs, so any sales revenues that can be earned out of workers spending their additional wage payments, is nullified by equal costs to business firms. Business firms therefore cannot accumulate profits by paying workers more wages.

      Capital goods expenditures increasing on the other hand do restore profitability, because capital goods expenditures show up as costs only much later on, via depreciation, and so any sales revenues that can be earned out of sellers selling capital goods, is NOT nullified by equal costs to business firms. Business firms therefore can accumulate profits by making capital goods investment.

      Coming out of a depression/recession, it takes time for firms to go from incurring losses, to making consistent profits. It is only through earning profits that firms can accumulate enough positive savings and capital to be able to hire more workers and immediately incur the costs of doing so.

      This is why “the” solution to depressions is actually for wage rates to collapse. When wage rates collapse, then investments that were postponed up until that time for “being too expensive”, start to become profitable. As capital goods investment rises alongside this fall in wage rates, business profitability rises.

      Once business profitability is sufficiently high, cross sectionally among firms and through time, then firms can begin to outbid each other more and more for workers, and wage rates will finally rise.

      What prevents recovery is a failure of wage rates to fall. When wage rates fail to fall, that continues to postpone the capital goods investment that is the main source of profitability restoration coming out of a depression.

      I’ll leave it to you to figure out just how widespread the problem of wage rates failing to fall is, and why wage rates fail to fall.

  4. Nikhil says:

    The example with the family is heartbreaking. So many people are hurting and they want to print more money, it’s shocking.

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