IMF Recommends Higher Inflation

[Gone4Good]

IMF economists suggest that central bankers raise their inflation targets to 4% from 2% . . .

In a new paper IMF economist Olivier Blanchard says policy makers need to consider radically different approaches to deal with major banking crises, pandemics or terrorist attacks. In particular, the IMF paper suggests shooting for a higher-level inflation in "normal time in order to increase the room for monetary policy to react to such shocks." Central banks may want to target 4% inflation, rather than the 2% target that most central banks now try to achieve, the IMF paper says.

At a 4% inflation rate, Mr. Blanchard says, short-term interest rates in placid economies likely would be around 6% to 7%, giving central bankers far more room to cut rates before they get near zero, after which it is nearly impossible to cut short-term rates further.

Paul Krugman agrees, arguing that higher inflation is needed to achieve full employment, especially in some countries in the Euro zone . . .

I would add, however, that there’s another case for a higher inflation rate — an argument made most forcefully by Akerlof, Dickens, and Perry (pdf). It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis.

In practice, a 2% inflation target has resulted in more like 2.5-3% inflation. So I assume a 4% target could yield a 5-6% actual inflation rate.

Ruh-Roh!

 

[Notmuchlonger]

So ER moves up a few years. With the life expectancy of people...I guess grab the golden jobs that will provide you with ER inflation adjusted pensions. Go get shot at for your country problem solved.


Oh because them jobs behind the desk for governments will be the first to go. As the easy not risk your life get a sweet pension deal go by the wayside. Better off risking your life and surviving. Better benefits that you can be more confident to collect on.

 

[free4now]

Theoretically this would come out in the wash for someone living off their assets; as inflation increased the portfolio and cost of living would both go up by about the same. But for people trying to save and get ahead, this sure would make it hard.

 

[yakers]

Would probably drive people out of cash, even bonds keep up over time. The idea is to have interest rates high enough that they can be cut when necessary, hitting 0% limits central bank abilities, currently there is 'monetary easing' --buying up bonds which is not an ideal alternative.

 

[Gone4Good]

Theoretically this would come out in the wash for someone living off their assets; as inflation increased the portfolio and cost of living would both go up by about the same.

I'm not so sure. Vanguard's bond index, for example, has yield of only 3.3% and an average maturity of 6.6 years. If inflation increases permanently to the 5-6% range, you've got a long time of negative real returns before your portfolio turns over completely to reflect the new interest rate environment. And I'm not sure how you recoup those initial losses. Sure, the new bonds you're rolling in to pay a higher nominal rate, but unless the real yield has increased enough to compensate for the purchasing power losses you took on the initial portfolio its difficult for me to see how you aren't harmed in real terms. (Incidentally, the Vanguard article Bonds and Rates: The reality behind the numbers purportedly demonstrating how a rising interest rate environment benefits bondholders only considers nominal returns.)

Same thing with equities. The S&P currently has an earnings yield of about 5%, which is way too low if inflation expectations are going to be in the same ballpark or higher. That means your stock earnings multiple should come down. HaHa posted a chart in another thread showing how poorly the S&P fared during our last bout of inflation. That was a lot more extreme than what is envisioned here, but it does go to show that equities aren't a sure-fire inflation hedge.

And with respect to workers, Krugman's point is that in periods of moderately low inflation workers underestimate inflation's impact and therefore don't demand enough wage increases to compensate. He's specifically urging a higher inflation rate as a way to bring down real wages. The supposed trade-off is higher employment . . . more people working for less money. But if you're someone who has a job, the idea is to try to trick you into a wage cut.