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Two lovers of
the notion that inflation can cure everything that ails an economy recently
squared off in a battle over who adores counterfeiting the most. Paul Krugman, who probably has a statue of Al Capone at his
bedside, chided Ben Bernanke in a New York Times Magazine article for his
unwillingness to raise the Fed's inflation target in order to reduce the
unemployment rate. The recipient of the Nobel Prize in economics penned an
article titled "Earth to Ben Bernanke" on April 24th. In it he
encouraged Bernanke to embrace the idea that more money printing can save the
world by writing, "Higher expected inflation would aid an economy."
Bernanke
addressed Krugman's comments at last week's FOMC
press conference. His dovish response directed towards Krugman's
commentary was, "The question is, does it make sense to actively seek a
higher inflation rate in order to achieve a slightly faster reduction in the
unemployment rate...the view of the committee is that that would be very
reckless." While it is commendable that Bernanke doesn't publicly admit
he wants to send inflation higher than it already is; the question remains
why he believes that higher inflation can cause even the slightest reduction
in unemployment.
What strikes
me the most is that neither the Nobel Prize winner nor the Chairman of the
Federal Reserve had the sagacity to completely repudiate the idea that
inflation can in any way reduce the unemployment rate. Even a cursory look at
the data throughout economic history proves that inflation is a destroyer of
jobs. All they would have to do is to look at the most salient periods of
inflation that occurred over the last 40 years and see how negatively it
affected the unemployment rate.
From 1971
(the year Nixon broke the gold window) through 1974, the annual percentage
change on the Consumer Price Index (CPI) increased from 4.4% to 11.0%.
According to Krugman and Bernanke, this should have
sent the unemployment rate crashing. However, the unemployment rate increased
from 6.1% at the end of 1971 to 7.2% in 1974. And since the unemployment rate
is a lagging indicator, that figure increased even further to 8.2% in
December of 1975.
In 1977 the
CPI was 6.5% and it shot all the way up to 13.5% in 1980. Just as it did in
the early part of the decade, the unemployment rate increased yet again
to 7.2% in 1980 and hit 10.8% by the end of 1982! Finally, the other salient
increase in the rate of inflation occurred between 1986 and 1990. The annual
percentage change of inflation in '86 was 1.9;, that
shot up to 5.4% in 1990. The unemployment rate started that period at 6.6%
and climbed to 7.3% at the end of 1991.
Therefore, I
have to ask our dear Fed Chairman and Nobel Prize winner where the evidence
is that inflation causes people to find work. In reality, it's the exact
opposite that occurs. Inflation robs the middle class of their purchasing power
and sends them onto the government dole. Inflation also destroys investment
in an economy because savers have no idea what interest rate is necessary to
charge in order to profitably lend out their money over an extended period of
time. And inflation causes tremendous economic imbalances, as capital is
diverted into ephemeral asset bubbles instead of being allocated in a more
viable manner.
If Krugman and Bernanke were correct in believing inflation
has a positive influence on the workforce, Zimbabwe and Argentina would both
be paragons of how to achieve full employment. The truth is that a high
unemployment rate is the simply the result of a weak economy. And an economy
can suffer through a recession while experiencing either inflation or
deflation. But when an economy experiences a significant increase in the rate
of inflation, it nearly always ends up with an unemployment rate that goes
along for the ride. We can only hope that central bankers in the developed
world assent to that principle very soon. Unfortunately, the ECB, BOJ and Fed
continue to believe a positive rate of inflation must be maintained at all
costs. That is one of the reasons why a high rate of unemployment has now
become a structural condition in most of the developed world.
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