Why Modest Inflation May Not Be Bad for the Economy
Central bankers seem to think that inflation is the economy’s worst enemy. But deep down, they may have a soft spot in their heart for it.
In a recent analysis, Paul McCulley, managing director at the giant bond fund Pimco, says the recent jump in commodity prices constitutes a "negative terms of trade shock." That's a fancy way of saying that, on balance, we’re worse off now than we were a year ago because we have to work longer hours for the same amount of oil and food.
“Put differently, we are less rich or more poor than we were before oil prices took off,” McCauley writes in the analysis.
Because of that, something has to give. The trade shock simultaneously, but temporarily, increases inflation and unemployment. It is, in other words, "stagflation lite."
Set against this rise in inflation, says McCulley, is a heavily indebted economy that's suffering asset price deflation - house prices have been falling for about two years now and the general trend in equities has been down since their multi-year peaks late last year.
This is where moderate inflation comes to the rescue. Not only does it cause real wages to adjust downward but negative real savings rates cause savers to lose out. This, McCulley says, is good for the aggregate. Falling real wages mean that workers don't price themselves out of the market. And negative savings rates mean the real value of debt also falls, which helps to alleviate the huge U.S. debt burden.
Every doctor knows that some diseases need to be treated with potent poisons, says McCulley. The point is to get the quantities right. Too little and the medicine does little good. Too much and it kills the patient. Inflation in the right dose, he claims, is like that medicine.
– By Ed Coury, senior editor and Midwest bureau chief for the Wall Street Journal Radio Network, Dow Jones & Co., and a reporter for WWJ Newsradio 950
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