In Fed and Out, Many Now Think Inflation Helps
WASHINGTON — Inflation is widely reviled as a kind of tax on modern life, but as Federal Reserve policy makers prepare to meet this week, there is growing concern inside and outside the Fed that inflation is not rising fast enough.
Some economists say more inflation is just what the American economy needs to escape from a half-decade of sluggish growth and high unemployment.
The Fed has worked for decades to suppress inflation, but economists, including Janet Yellen, President Obama’s nominee to lead the Fed starting next year, have long argued that a little inflation is particularly valuable when the economy is weak. Rising prices help companies increase profits; rising wages help borrowers repay debts. Inflation also encourages people and businesses to borrow money and spend it more quickly.
The school board in Anchorage, Alaska, for example, is counting on inflation to keep a lid on teachers’ wages. Retailers including Costco and Walmart are hoping for higher inflation to increase profits. The federal government expects inflation to ease the burden of its debts. Yet by one measure, inflation rose at an annual pace of 1.2 percent in August, just above the lowest pace on record.
“Weighed against the political, social and economic risks of continued slow growth after a once-in-a-century financial crisis, a sustained burst of moderate inflation is not something to worry about,” Kenneth S. Rogoff, a Harvard economist, wrote recently. “It should be embraced.”
The Fed, in a break from its historic focus on suppressing inflation, has tried since the financial crisis to keep prices rising about 2 percent a year. Some Fed officials cite the slower pace of inflation as a reason, alongside reducing unemployment, to continue the central bank’s stimulus campaign.
Critics, including Professor Rogoff, say the Fed is being much too meek. He says that inflation should be pushed as high as 6 percent a year for a few years, a rate not seen since the early 1980s. And he compared the Fed’s caution to not swinging hard enough at a golf ball in a sand trap. “You need to hit it more firmly to get it up onto the grass,” he said. “As long as you’re in the sand trap, tapping it around is not enough.”
All this talk has prompted dismay among economists who see little benefit in inflation, and who warn that the Fed could lose control of prices as the economy recovers. As inflation accelerates, economists agree that any benefits can be quickly outstripped by the disruptive consequences of people rushing to spend money as soon as possible. Rising inflation also punishes people living on fixed incomes, and it discourages lending and long-term investments, imposing an enduring restraint on economic growth even if the inflation subsides.
“The spectacle of American central bankers trying to press the inflation rate higher in the aftermath of the 2008 crisis is virtually without precedent,” Alan Greenspan, the former Fed chairman, wrote in a new book, “The Map and the Territory.” He said the effort could end in double-digit inflation.
The current generation of policy makers came of age in the 1970s, when a higher tolerance for inflation did not deliver the promised benefits. Instead, Western economies fell into “stagflation” — rising prices, little growth.
Lately, however, the 1970s have seemed a less relevant cautionary tale than the fate of Japan, where prices have been in general decline since the late 1990s. Kariya, a popular instant dinner of curry in a pouch that cost 120 yen in 2000, can now be found for 68 yen, according to the blog Yen for Living.
This enduring deflation, which policy makers are now trying to end, kept the economy in retreat as people hesitated to make purchases, because prices were falling, or to borrow money, because the cost of repayment was rising.
“Low inflation is not good for the economy because very low inflation increases the risks of deflation, which can cause an economy to stagnate,” the Fed’s chairman, Ben S. Bernanke, a student of Japan’s deflation, said in July. “The evidence is that falling and low inflation can be very bad for an economy.”
There is evidence that low inflation is hurting the American economy.
“I’ve always said that a little inflation is good,” Richard A. Galanti, Costco’s chief financial officer, said in December 2008. He explained that the retailer is generally able to expand its profit margins and its sales when prices are rising. This month, Mr. Galanti told analysts that sluggish inflation was one reason the company had reported its slowest revenue growth since the recession.
Executives at Walmart, Rent-A-Center and Spartan Stores, a Michigan grocery chain, have similarly bemoaned the lack of inflation in recent months.
Many households also have reason to miss higher inflation. Historically, higher prices have led to higher wages, allowing borrowers to repay fixed debts like mortgage loans more easily. Over the five years before 2008, inflation raised prices 10 percent. Over the last five years, prices rose 8 percent. At the current pace, prices would rise 6 percent over the next five years.
“Let me just remind everyone that inflation falling below our target of 2 percent is costly,” Charles L. Evans, the president of the Federal Reserve Bank of Chicago, said in a speech in Madison, Wis., this month. “If inflation is lower than expected, then debt financing is more burdensome than borrowers expected. Problems of debt overhang become that much worse for the economy.”
Inflation also helps workers find jobs, according. to an influential 1996 paper by the economist George Akerlof and two co-authors. Rising prices allows companies to increase profit margins quietly, by not raising wages, which in turn makes it profitable for companies to hire additional workers. Lower rates of inflation have the opposite effect, making it harder to find work.
Companies could cut wages, of course. But there is ample evidence that even during economic downturns, companies are reluctant to do so. Federal data show a large spike since the recession in the share of workers reporting no change in wages, but a much smaller increase in workers reporting wage cuts, according to an analysis by the Federal Reserve Bank of San Francisco. There is, in practice, an invisible wall preventing pay cuts. The standard explanation is that employers fear that workers will be angry and therefore less productive.
“I want to be really careful about advocating for lower wages because I typically advocate for the other side of that equation,” said Jared Bernstein, a fellow at the left-leaning Center on Budget and Policy Priorities and a former economic adviser to Vice President Joseph R. Biden Jr. “But I think higher inflation would help.”
The Anchorage school board, facing pressure to cut costs because of a budget shortfall, began contract negotiations with its 3,500 teachers this year by proposing to freeze rather than cut wages. The final deal, completed last month, gives the teachers raises of 1 percent in each of the next three years.
Teachers, while not thrilled, described the deal as better than a pay cut. But it is likely, in effect, to cut the teachers’ pay. Economists expect prices to rise about 2 percent a year over the next three years, so even as the teachers take home more dollars, those dollars would have less value. Instead of a 1 percent annual increase, the teachers would fall behind by 1 percent a year.
“We feel like this contract still allows us to attract and retain quality educators,” said Ed Graff, the Anchorage school district superintendent.
In June, Caterpillar, the industrial equipment maker, persuaded several hundred workers at a Wisconsin factory to accept a six-year wage freeze. The company described the workers as overpaid, but it did not seek direct cuts.
The slow pace of inflation, however, minimizes the benefits. Seeking further savings, Caterpillar has since laid off almost half of the workers.