2010 June 11
by Dave

The increasing volume of and media attention being given to both inflation and deficit hawks is starting to worry me quite a bit. They seem to be gaining political traction around the world and are threatening to, at worst, throw the global economy back in the tank or, at best, take us back to exactly where we were when this whole mess started.

These offending economists and politicians are groups that only know how to use hammers. They’ve really wanted to help deal with the global financial crisis, but the very thought of bringing a hammer to bear on the situation has been laughable so far. Finally some credible folks mentioned that there may be some nails of various sorts that need hitting at some point in the future so we should all be ready to employ hammers when necessary. The mere mention of the possibility of nails got the hammer wielders swinging at anything that moves.

Unfortunately they are likely to end up hitting someone carrying something heavy on the foot.

We should not raise interest rates to combat the chimerical threat of hyper inflation for several reasons. First and foremost is the current level of core cpi inflation. This number is made up of things that are not repriced frequently and thus represent a solid expectation of what costs will be in the future. It is running at less than one percent right now. This is the lowest that it has been for a long time. It is getting low enough that we are very close to deflation land, and deflationary expectations are much harder to fight than inflationary expectations. If people think that things will be cheaper in three months, then they won’t buy anything. It ends up feeding itself relentlessly. There is an infinite ability to not buy stuff but only a finite ability to buy stuff, hence consumer inflationary pressure is self limiting and has an upward bound that takes artificial input to blast through.

The second reason why raising interest rates to fight inflation is not such a great idea right now is that tons of money is sitting on the sidelines of the economy and is not helping growth and job creation. If you raise rates you will disincentavise borrowing to grow business and incentivise saving instead of investing. Money hoarding hurts the recovery.

Finally, a few quarters of four or five percent inflation would not be the end of the world. It would weaken the dollar and make the deficit cheaper. If it were coupled with a strengthening of the Yuan it would help global trade/currency imbalances. Also it would help all of the people that are upside down on their mortgages.

Deficit reduction is even more ridiculous right now. Cutting stimulus spending and unemployment benefits will not reduce the deficit. These cuts will slow the economic recovery and thus reduce future revenue while at the same time hurting people that need help. Cutting off your nose to spite your face because your political ideology tells you that government spending is evil is reckless policy.

The kicker is that it is taboo for politicians to discuss true deficit reduction. The two entitlement programs of Social Security and Medicare are the fiscal drains on the government that are actually predicted to cause the ballooning budget deficits coming in future decades. Law makers could implement policies now that would start cutting the costs of those programs five to ten years from now and actually make real headway against the deficit. That would be responsible and could be done today without killing the recovery.

Unfortunately if a politician from either party even mentions Social Security or Medicare they risk calling down a shit storm from voters on themselves. Remember the competing rhetoric over who’s Social Security box was locked tighter in the presidential debate ten years ago? Tea party activists want the government to cut the deficit and to keep it’s hands off of Medicare. They can’t have both. Politicians and media outlets across the political spectrum need to start gently explaining all of these things to voters or else we risk letting loose two dangerous breeds of hawk. Of course the only things that they are likely to kill are jobs.

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