In her Washington Post column Megan McArdle argues that the consequences of throwing the economy into recession would be worse than allowing inflation to increase:
This story is usually told triumphantly — brave Volcker, taking the painful but necessary steps! Yet now that our own Fed chair may face a similarly ugly trade-off, I confess I’m thinking more about the deep pain that recession caused. It is, of course, bad to lose 8 percent of your purchasing power to inflation. But it’s even worse to lose a hundred percent of it to unemployment — and the collective suffering of those who lose their jobs is arguably much greater than the pains of households strained by inflation.
So I asked John Huizinga, who taught me macroeconomics 20 years ago at the University of Chicago’s Booth School of Business: Why is a recession better than high inflation? His answer, in brief: It isn’t. “If it were me and I was in charge of monetary policy, would I cause a big recession to keep inflation low? No. But I would try to get to a stable inflation rate, and then gradually lower the rate of inflation over time.â€
from which I conclude that she is too young to remember the adverse consequences of the inflation of the 1970s and early 1980s. High inflation hurts the poor and benefits the rich. It contributed to the financialization of the economy. And worst of all persistent high inflation runs the risk of a catastrophic loss of confidence in the currency, i.e. hyperinflation.
Where I believe that Ms. McArdle and Dr. Huizinga err the most is in believing that fine-tuning is possible. It isn’t. Economists simply don’t know how to accomplish it. That’s why there is a choice: inflation or recession and IMO the risks that accompany persistent high inflation cannot be mitigated and are worth avoiding.
Update
In response to criticisms in comments, let me explain how those with the highest incomes actually benefit from higher inflation. I think we can all agree that the poor are hurt by high inflation. It’s less obvious that those with higher incomes benefit.
Can we all agree that borrowers benefit from higher inflation? They service and pay off debts with cheaper dollars than they originally borrowed. Who borrows the most?
The answer is that the higher your income, the more you borrow:
Source: J. W. Mason, “Income Distribution, Household Debt, and Aggregate Demand: A Critical Assessment”
That was a lesson I learned when I was a kid. The richest guy I’ve ever met (he would be a billionaire by today’s standards) also held more debt than anybody I’ve ever known. He was proud of it; bragged about it. The secret to riches isn’t avoiding debt; it’s managing debt.
Consequently, those in the top decile of income earners actually benefit from higher inflation. Not only are they more likely to be able to command raises than those in the lower deciles, their significantly higher debt is inflated away.
Experience has been repeated so many times that it may as well be a law of nature; but forcing high inflation to low inflation is more painful than letting inflation go on in the short term / medium term.
It is only when there is nothing to preserve (i.e. hyperinflation as in Weimar Germany 1923) that fixing inflation is less painful than the alternative.
If fighting inflation was unambiguously less painful than the alternative; it wouldn’t have the reputation of bedeviling governments since antiquity.
By the way. I like how optimistic many are that there is a choice on offer between inflation and recession.
The pessimist in me says its possible to have both (recession and inflation). Indeed the economic data is pointing that way….
Several themes here.
“High inflation hurts the poor and benefits the rich.”
Not quite that simple. Inflation hurts the poor (and fixed income crowd) to the extent they cannot demand wage increases to match their diminishment in purchasing power. However, they tend to be more debt heavy in their financial profile than the rich and are beneficiaries of repaying that debt with cheaper dollars.
The rich are not benefitted, as the value of their disproportionate profile in financial assets declines. The longer the duration in fixed income the worse. And equities do not do well: see the 70’s and now.
Inflation harms everyone except government.
I don’t think inflation contributed to financialization. Incompetent US operating management, poor product quality, regulatory encroachment – particularly in the environmental aspect – consumer buying behavior based upon price, and not on other considerations, and predatory trade practices all lead to the change in relative importance of finance and industry. Finance simply facilitated operator’s decisions by channeling capital, facilitating trade finance, liquidity trading and risk management. No car executive ever woke up one morning and said, “gee, Solomon Brothers had a great day trading bonds yesterday, let’s build engines in Mexico.”
“Where I believe that Ms. McArdle and Dr. Huizinga err the most is in believing that fine-tuning is possible.”
There’s is a child-like notion. I doubt either of them have been in an executive position in their lives.
“Consequently, those in the top decile of income earners actually benefit from higher inflation.”
I think I like Drew’s explanation a bit better. There are offsets to the benefits and absolute benefit or loss is probably unique to each individual. The other part of the question is who is hurt the most by losing their job and who is most likely to lose their job in a recession?
Steve
That’s a selective stat, Dave; else I would agree with your update. But you are invoking scale on the debt side, and conveniently forgetting scale on the inflation destruction of assets side.
Further, you are citing a tiny, tiny fraction of the rich. The truly super rich who use exotic schemes. Faulty analysis. That’s billionaire territory. Policy derived from that data set is foolishness.
Very, very few “rich” people live on debt. If you define “rich” as $5MM – $100MM. And that’s where the volume is. People with $20MM – $50MM in net worth pay cash for homes, boats, exotic cars, club memberships etc. They are not loaded up on debt. You may want it to be so to support your argument, but its a classic case of sampling error.
Dave, I know, I am one and know lots of people who are.
But that same crew are subject to long duration fixed income instrument price declines. Equity declines. And probably very soon, home price declines. No tears. These assets benefitted from printing money. But “the rich” are not cheering inflation. They are going to get screwed just like The Average Joe. They can just withstand it better.
If you want to look for really rich scoundrels, look at the Gates, Buffets, Zuckerbergs, Bezos, Clintons, Bidens, Pelosis etc etc of the world. All assisted by government. And what do you know, all Democrats.
Back in my young adulthood it used to be. Back then 70% of Americans owned 70% of assets but things have changed. Now a very small segment of the population owns an enormous proportion of assets.