The actual benefits of inflation outweigh the theoretical costs | Comment


The UK’s chief economist was criticized two weeks ago for saying something that was obvious not just to Britain but to most of the developed world. Huw Pill said in a podcast Some companies and workers have to accept that they are in a bad position. And he was right. The economy has been impoverished in real terms by a barrage of real shocks over the past three years: the pandemic, the war in Ukraine, and most recently a major food price shock.

The dilemma facing central banks — and therefore investors — is how to respond. Should monetary authorities move quickly to rein in the resulting inflation, or err on the side of softness and tolerate the current upward shift in the price level?

In the age of inflation-targeting central banks, the answer may seem obvious. Inflation is always and everywhere a bad thing. However, economic theory has difficulty identifying the social costs imposed by an increase in the price level.

Economics textbooks say that inflation is a huge deadweight loss Menu costs: Waste of resources when companies have to change their price levels from time to time. It has always seemed understated and must be almost irrelevant in the digital age. Another downside of price hikes is said Zapa skin costs, shorthand for the difficulty of moving money between deposit and savings accounts to protect cash balances. Now that smartphone users can switch banks with a swipe of their thumb, the idea seems pretty quaint.

The most serious charge is the uncertainty that inflation introduces into financial planning. But this is more about the volatility of inflation than its level, and is therefore a reason to avoid erratic or inefficient policy rather than keeping inflation below a given rate.

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Finally, there is the moral argument that any reduction in the real value of a national currency unit is essentially theft. That old accusation basically avoids the issue. Demonetization has winners and losers, positive and negative economic consequences. The goal of economic theory is to allow authorities to analyze trade exchanges.

If the theoretical costs of inflation are elusive, the potential benefits it can provide are more tangible. They are directly related to two of the most important economic challenges facing advanced economies today.

First, there is the inescapable reality of the major real shocks to income and wealth Bill mentions. Some of them may be temporary. Others indicate permanent changes in terms of trade and relative wealth of countries. They all involve significant changes in relative prices within economies and thus the fortunes of various industries. For example, energy-intensive industries suffer from rising oil and gas prices, while import-heavy companies lose competitiveness if cross-border supply chains are disrupted.

Monetary policy cannot prevent these shocks: central bankers cannot find vaccines, end wars, or print tomatoes. What they can do affects the resulting economic reform.

One option is shock therapy. By keeping inflation low at all costs, central banks allow large-scale relative price changes to occur in a disruptive and discontinuous fashion. That would certainly mean a sharp rise in unemployment. The alternative is to allow the general price level to rise, making it easier for new uncompetitive sectors to reduce wages in real terms without losing jobs. Restructuring the economy is very easy.

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Mervyn King, then governor of the Bank of England, made this point publicly in 2010. Better to keep inflation at an average of 5% while people keep their jobs for a couple of years than to crucify the economy by crossing an arbitrary inflation target. 2%. James Forder, editor Macroeconomics and the myth of the Phillips curvementions that The then president of the ECB, Mario Draghi, also endorsed it Lubrication After the 2012 Eurozone crisis.

Today’s central bankers are willing to explain that the underlying causes of the cost-of-living crisis are beyond their grasp. But they are less clear in suggesting that inflation is the least damaging way to release pressure.

The second major challenge that threatens the stability of advanced economies today is the existence of huge financial imbalances that have accumulated over the past two decades.

During the 2008 crisis, Kenneth Rogoff, former IMF chief economist, He argued that inflation was the only viable way to reduce the real value of debt and hedge the enormous macroeconomic risks in overpriced real estate markets financed by unsustainable mortgages. At the time, US public debt was 73% of GDP; Within 15 years, the ratio reached 133%. Meanwhile, U.S. home prices peaked last year, 45% higher in real terms than Rogoff made his claim. These financial disparities are neither socially sustainable nor economically efficient.

As with labor market changes, there is a conventional solution: let fiscal policy take the load. However, the transparent tax level and distribution required to restore wealth balance will be a difficult task even in less politically polarized times. It would be easier, more convenient, and fairer to let inflation reduce epic balances to more manageable levels.

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Higher prices are already working their magic. By the end of 2022, despite continuing fiscal deficits, US public debt was reduced by nearly twelve percentage points of GDP. Such miracles are possible when nominal GDP grows by 21% in two years. The country’s residential real estate sector is already 7% cheaper in real terms than it was at its peak, but without the risk of devastating credit deflation, which would cause a nominal decline in house prices.

Although the current generation of central bankers in advanced economies seem reluctant to say it out loud, temporarily rising inflation is part of the solution to the challenges their economies face. Investors should bet accordingly. Ultimately, the practical benefits of inflation outweigh its theoretical costs.

Authors are essayists Reuters Breaking Views. Opinions are yours. Translation, in Carlos Gomez belowIt is responsible Five days

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