Yet most economists persist in a negative view of higher inflation. One hypothesis is that inflation confuses people. Most people are not hyper-rational calculating machines, and they tend to see higher inflationary prices as representing real economic changes. So producers might see higher nominal demands for their goods and think they have suddenly become more popular with consumers, rather than merely being caught up in an inflationary spiral.
Still, under this scenario inflation doesn’t have to be bad. If producers increase their outputs and hire more labor, that tends to boost economies, not harm them. That is all the more true if there is some initial degree of output-restricting monopoly.
But what if producers eventually learn they are facing mere inflation and have to go back to their previous decisions? That would surely carry costs. Maybe, but the worst economic downturns involve virtually all sectors contracting at roughly the same time, rather than the main problem being a lot of churn and “to and fro.” Some of these switching costs might be real, but that doesn’t seem to account for why people dislike inflation so much. And in the current situation, the real “to and fro” costs are coming from waves of the pandemic, not from monetary policy.
One argument, associated with the Austrian school of economics, is that inflation leads to too much credit and thus too much long-term investment, in a manner that eventually proves unsustainable. Regardless of whether that view is sometimes true, under current conditions investors seem more worried than pleased by inflation.
So the question remains: Why is inflation so bad? Keep in mind that most government benefits are already indexed to inflation. Capital gains taxation is not, however — and therein lies a definite cost to price inflation, namely that it raises the real rate of tax on capital investments. Even so, that does not explain how inflation seems to carry such broad-based costs, including on the majority of Americans who do not hold significant equity positions.
I am left with two major worries. First, higher rates of inflation redistribute wealth in a disruptive manner. For better or worse, more and more Americans are employed in the relatively bureaucratic service sector, which includes education, health care and government. If price inflation spikes as high as 6%, most of those workers do not rapidly receive an offsetting wage hike to restore their previous standards of living.
They might get higher pay by getting a new job, or by credibly threatening to leave. But that’s often a tense and unsettling position, from both a personal and professional standpoint. People might even have received stimulus dollars earlier in the pandemic, either directly or indirectly, and thus broken even or come out ahead. Still, with inflation, they will experience a loss of purchasing power, and they will hate it.
The second major worry is that inflation tends to require a subsequent disinflation, if only because people hate inflation so much. And we macroeconomists know that disinflations (or outright deflations) tend to bring recessions. When the U.S. Federal Reserve tightens monetary policy by a significant amount, aggregate demand in the economy falls, leading to losses in output and employment.
Of course, that’s a funny way of explaining why higher rates of price inflation are bad: Essentially, inflation is bad because it has to end. A subtler version of this theory is that workers and voters have only a limited tolerance for disruptions — and when they occur, we end up making blunders in our efforts to get out of them.
The proper critique of inflation is thus quite general. A pandemic is also a disruption, and we’ve made many mistakes in our efforts to end that as well. One of those mistakes, in fact, has been excess inflation. It will not be our last mistake, as we are still building our ever-widening circle of errors.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include “Big Business: A Love Letter to an American Anti-Hero.”
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