Who’s afraid of a little inflation?

Recently a number of prominent, mostly conservative economists have begun publicly worrying that the Fed’s unorthodox monetary policy will lead to inflation at some point in the not so distant future. Some alarmists in the media have picked up on this and warned publicly about the danger of hyper-inflation. Apparently they cannot distinguish between 5-8% inflation and what is happening in Zimbabwe right now.

Unfortunately, a lot of sane people are wasting a lot of time and a bit of credibility arguing that we won’t actually see any inflation as a result of what essentially amounts to printing a lot of money. Of course there will be some inflation when the economy picks up again, that's normal.

One of the most important pieces of advice that was given to me back when I was a member of the Debating Union at the university was that the question that most frequently needs to be asked is: "So what?"

Far too often, someone will spend most of their time demonstrating how your side's plan of action leads to some consequence. In this case, conservative economists have established a fairly strong case that there will be some inflation in the future as a result of the Fed's current actions. What has not happened, however, is that they have not told us why 5-8% inflation is more harmful than strangling a nascent recovery by tightening monetary policy too early.

At this point, I'm not entirely convinced that such a rate of inflation would be harmful in the short-run. With governments and consumers deeply in debt and unwilling to spend because of their debt obligations, inflating some of those away may actually be part of what is necessary to end the current crisis.

Stimulating Thoughts

With all the unhappiness about the size and content of the stimulus, how is it that centrists have managed to force changes that address none of the complaints, valid or not, about the stimulus?

First a quick recap of the types of complaints:

Paul Krugman’s complaints are twofold. First, he thinks the stimulus bill is too small. This complaint is driven by a belief that the economy is going to face a $2.9 trillion output gap. Even if  all $800 billion or so were immediate spending, it wouldn’t be large enough to plug that gap.

Secondly, he rightly points out that large parts of the “stimulus” will not lead to immediate spending. Particularly, tax cuts are currently ineffective since consumers will probably just pocket most of the money and not spend it right now. Other critics singled out parts of the spending provisions, which they thought were not effective at stimulating the economy. The CBO estimates that only $525 billion in tax cuts and spending would happen over the next two years, with the rest falling later in the coming decade.

The Republicans complained initially that the plan was too large and could not be afforded, before going on to propose their own $3 trillion plan composed entirely of tax cuts.

With the massive current demand for US Treasury bills, thanks to the perception that they are the safest investment available, it seems difficult to claim we can’t afford stimulus of this magnitude; however, Willem Buiter offers a reasonable argument. The problem, in his view is not that the proposed deficit could not be financed, but that Congress cannot credibly claim that the increase in spending is temporary or that it will raise taxes to compensate. This will erode confidence in US ability to repay its debts, and without that confidence, the two factors that make such a deficit relatively painless to finance at the present time: the status of the US dollar as a reserve currency and the ability of the US government to borrow abroad in its own currency would disappear.

Now, with the aforementioned complaints in mind, would you:

a)      Throw in more spending to make the bill bigger

b)      Cut down the cost of the bill

c)      Make sure that the money is spent quickly and creates as many jobs as possible 

d)     Some mix of the first three

e)     Cut out the most stimulating parts like help to states, unemployment benefits, etc. and offer relatively rich people tax credits for flipping houses

Now, if you’re wondering why option e) is there and what it has to do with any of the aforementioned problems with the stimulus bill, it’s there because that’s what the Senate moderates actually opted to do.

Getting it right and getting it right now

The proposed stimulus bill passed in the House with absolutely no Republican votes, despite tax cuts and other concessions inserted to entice conservative lawmakers to support the bill. Now the bill has moved to the Senate, where Republicans could theoretically filibuster it to death. This has led to attempts by both sides to make changes to the bill in order to ensure its passage; however, most of the cuts seem to be largely symbolic in nature, rather than significant reductions in the overall cost (see NY Times article).

The Republicans’ main complaints are that the proposed stimulus is nothing but a long-standing Democratic wish list, it’s too expensive, and it does not stimulate the economy quickly enough. No amount of cosmetic changes will negate these complaints. Indeed the real problem is that the sense of urgency, in part fueled by long inactivity during the final months of the Bush presidency, has caused Democrats to throw caution to the wind. The stimulus bill seems to be the result of a quick brain-storming session where lawmakers thought of every possible way to spend money then slapped it all together into one giant bill in the name of expediency.

In my opinion, the best way forward would be to cut the bill in two. Separate out the funding that can immediately stimulate the economy: the help to states, payroll tax holiday, funding for “shovel-ready” projects, etc. and pass that part immediately. Then carefully debate the non-immediate spending and long-term reforms, which somehow ended up in a stimulus bill. Whereas stimulus is needed in the short- and medium-term so badly at this point that anything which creates jobs is useful, only some of the non-stimulus spending is clearly justifiable on its own merits; it would be nice if it were not all rammed through without some debate.

Critics of the stimulus claim that only 37% of the electorate supports the bill (see a recent Gallup poll). While technically true, the part they like to leave out is that an additional 38% of the electorate would support the bill with some sort of changes. President Obama has indicated that he would like to pass a bill enjoying broad support (hence the concessions to Republicans even though their votes aren’t strictly necessary), but he also worries that the longer Congress takes to put it on his desk for signature, the more jobs will be lost (see his Op-Ed piece in the Washington Post). Splitting the bill in two would allow quick passage of a much cheaper measure that would pack almost the same punch in the short-term, while buying time to get the long-term part right.