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Blog

    The Fed Cannot Employ, It Can Only Inflate

    05/13/2013

    Paul Krugman is at it again. The Nobel Prize-winning, devoutly Keynesian economist argued in a recent column that the thing needed to cure the sluggish American economy is, wait for it, more inflation. This is the classic Keynesian view that the Federal Reserve can stimulate the economy by inflating the currency. Krugman is doubtless basing his reasoning at least partially on the well known, but now outdated Phillips Curve, which demonstrated a historical inverse correlation between inflation and unemployment.

    What the Phillips Curve fails to demonstrate, however, is any causal relation between rising inflation and lower unemployment. No doubt, prices tend to rise during periods of robust economic activity due to increased demand resulting from increased wealth, and prices fall during contractions simply because people have less money to spend. It does not follow, however, that an artificial increase in inflation will create jobs. In fact, it is likely to do just the opposite. For this reason, the Phillips Curve has largely been abandoned by the field of modern economics.

    For one thing, rising prices create uncertainty, and business owners are unlikely to invest if they have no idea what their costs are going to be in the future. What company would commit to hiring new employees when the costs of their suppliers could unexpectedly rise at any time?

    Nor is more inflation beneficial for workers. Wages are notoriously slow to adjust to price changes, so a rising price level would leave workers with steadily declining real wages, in addition to eating away at their savings and any cash on hand. At no point in history has a general decline in real wealth been the harbinger of great economic prosperity.

    There are administrative costs of inflation too, as merchants are forced to update their catalogues and price lists frequently in order to stay abreast of the latest changes, and banks are required to continually update their interest rates.

    Krugman’s ideas are based in part on the assumption that inflation is currently very low. This is an understandable thing to think if one merely glances at the Bureau of Labor Statistics’ Consumer Price Index, but is less credible when actually trying to purchase groceries or household items. The Consumer Price Index(CPI) is a notoriously poor gauge of inflation, since it measures a fixed basket of goods that do not change over time to reflect advancing technologies and shifting consumer preferences.

    The Federal Reserve has already devalued the currency by pumping unprecedented levels of cash into the economy through its quantitative easing program. The result has not been more jobs, but rather artificially low interest rates that discourage saving and punish those who were responsible with their money before the recession. Saving is important to provide capital for business investments and to provide for workers in their old age. Policy makers are already fretting heavily over the underfunding of America’s Social Security and private pension systems, a problem partially created by the Fed’s easy money practices.

    To suggest that these policies should be continued and even increased is to show a blatant disregard for the well being of the economy and all those struggling to make ends meet within it. Inflation is never a desirable policy goal. If we want to see jobs return to the private sector, the only way is to allow prices to stabilize and to promote sound money so that employers regain the confidence to invest and employ.