Will be in Dallas for a few more days. Just so you don’t think I disappeared, I dug up an old post I wrote but never posted. I saw the 3rd quarter NGDP was about 4%–surprised by the high deflator (something I can’t explain.) Looks like final sales (Woolsey’s target) were much lower than GDP growth. I will try to catch up on comments early next week. Here’s something to look at until then:
We are taught in basic economics that an unexpected increase in inflation hurt savers. But I’m a very heavy saver, and I think a bit more inflation would help me. Partly that’s because I have lots of equities, but I’d still feel this way if I had to live the next 30 years as a retiree surviving on T-bill interest.
You might argue that I am confusing real and nominal interest rates. Yes, inflation would raise nominal rates, but surely it wouldn’t raise the real yield on T-bills? In fact, I think a little bit more inflation would raise real T-bill yields. Maybe not right away, but within two or three more years.
To make this argument we have to remember a few important macro concepts, and also empirical regularities:
1. Near zero rate traps are associated with very low inflation and a depressed real economy. The depressed real economy often leads to low real interest rates, even if the economy is growing. The best example occurred in 1933-40, when real interest rates remained low despite fast RGDP growth. The explanation was that although RGDP growth was high, the level of RGDP remained low throughout the 1930s—and this led to low levels of real investment, and hence not much demand for credit. Japan is another example.
2. The economy should be able to fully adjust to an adverse demand shock within a few years, as wages and prices adjust. However, the adjustment may take longer if various real factors delay the recovery:
a. A higher real minimum wage, caused by legislation or disinflation.
b. Extended unemployment insurance, which reduces downward wage flexibility.
d. Higher taxes, which discourage investment.
e. Increased regulations that discourage small firms from adding employees.
These factors cannot, by themselves, explain the current high unemployment. But they can slow the adjustment to lower unemployment in an economy where the central bank is not providing enough money for the usual recovery–which is normally associated with fast NGDP growth.
3. AD shocks can amplify AS problems, and vice versa. Just as the tight money of 2008 caused Congress to extend UI for 99 weeks, an easier money policy that boosts nominal growth and inflation will cause Congress to reduce the benefits much sooner. And the real minimum wage would fall. Some economists say the problem is almost entirely a deficiency of AD. Other RBC-types say labor market distortions are a big problem. But since the labor market distortions are mostly a response to the falling AD, the policy implications of each view are the same—we need more AD.
Here’s what people forget. Monetary policy was far more inflationary in 1990-2007, but savers were also far better off. The recent disinflation has hurt savers badly because it has lowered the real rate of return on their investments. Why is the textbook view wrong? Because it assumes money neutrality, i.e. it assumes inflation is a zero sum game. In fact, unexpected inflation could cause the economy to recover, after which real returns on investment like T-bills would return to their normal level. Yes, there may be a “new normal” because of high savings rates in Asia, but it’s hard for me to believe that the current minus 0.50% yield on 5 years TIPS is the new normal. I think it at least partly reflects the weak economy. If we get stuck in a long period of economic weakness (as debt markets are now forecasting), then savers will do very poorly, even as they experience the lowest inflation rates of their lives.
So no, I’m not trying to stick it to savers; I’m trying to help them. And I’m trying to help borrowers as well. Economics is not a zero sum game. Right now an extra trillion dollars in NGDP would be more than 50% real, and that’s a lot of extra income to make everyone better off.
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