If someone who doesn’t have much of a background in
economics reads what the experts have to say, or hears about it on television,
he or she is likely to accept on faith what is being said. The trouble is these
experts rarely mention the fact that they are only sharing their own opinion,
or repeating a particular theory that other economic experts have shown to be riddled
with holes. And the economists who write columns or speak on television never
mention that their jobs or the performance of their stock portfolios depends on
being able to convince people to come around to their way of thinking.
The partisan two-party system in this country gives people
another way of deciding whether or not they agree with what a particular
economic expert is saying. When a conservative voter hears the word
“austerity,” he or she is apt to think “lower taxes,” and when a liberal voter
hears the word “austerity” he or she is apt to think “fewer jobs” or “cuts in
services.”
Inflation
Most people have an impression of what is meant by
inflation, but it is possible that some people do not understand the nuances.
Inflation can be beneficial when it is moderate, but it can be dangerous if it
is either too low (leading to deflation or disinflation) or too high (leading
to hyperinflation). In other words,
inflation is not inherently a bad thing or a good thing.
Still, the word “inflation” is so dreaded by Americans that
no one dares to speak its name. One of the images that come to mind for
Americans is that of the German citizen, who in the 1920’s had to withdraw a
wheelbarrow full of cash from the bank just to buy a loaf of bread.
What happened in Germany was the result of a political
decision to print money in order to pay off war debts. Inflation, in this
instance, was the result of poor decision-making. First, the government led the
country recklessly into war, thereby creating an impossible level of debt. Secondly,
the government initiated a disastrous monetary policy that was based solely on
short-term expedience. The German example does not – or should not – imply that inflation is some sort of a wild beast that,
given the slightest encouragement, will run out of control.
For many people, the term “inflation” is painful because it
evokes the experience of the United States during the 1970’s. In this instance,
a sharp increase in the price of oil contributed to rising prices for other
essential goods. So, instead of there being a sudden increase in the amount of currency,
an event occurred (the Arab Oil Embargo, which was a response to U.S. military
support for Israel during the Yom Kippur War)
which abruptly reduced the buying power of American dollars.
The period of inflation which occurred during the 1970’s
etched such a deep, traumatic memory in the American psyche because, among
other things, it forced the country to ration gasoline. In some instances, a
customer might only be allowed ten gallons per visit. If such a turn of events
were to occur today, many drivers of large SUV’s could not make it home from
the gas station.
 |
| The 1970's - A Period of High Inflation |
Inflation is the temporary end result of a particular chain
of events. Specifically, there are times when the amount of money that is in
circulation abruptly increases. For example, in the last several years, China
has benefited from some very favorable trade agreements with the United States.
As a result, there has been a steady increase in the number of American dollars
pouring into and circulating within the Chinese economy. Their manufacturing
sector has grown to the point that millions of new jobs have been created, wages
increased, and the standard of living for ordinary Chinese has improved. Despite
all of these benefits, the change has been disruptive. The ability of domestic
producers to increase supply has lagged behind the increase in demand for goods
and services. Owing to the inexorable Law of Supply and Demand, this has led to
price increases.
In some instances, then, inflation may be viewed as the
price one pays for economic growth. In China, the rate of job creation and wage
increases will eventually slow down, or supply will catch up with demand. It is
very unlikely that the situation will get out of hand. Experience has taught
economists and policy makers that inflation can be reliably and effectively managed.
In the early 1990’s, Canada set a target rate of inflation of between 1 and 3% and
has been able to remain on target ever since.
If people respond to increased money supply by buying more goods,
this increases demand. When demand for goods increases, businesses and
manufacturers are likely to respond by: (a) increasing production, (b) increasing
prices, or (c) hiring more workers. In response to increased demand, manufacturers
may need to purchase additional raw materials, only to discover that other
manufacturers are also busy purchasing raw materials, and thereby driving up
prices. If prices continue to rise and money is plentiful, people will soon realize
that if they buy that washing machine today, it will be less expensive than if
they were to wait a couple of months. Thus,
inflation can spur spending and hiring.
As noted a moment ago, the word “inflation” is frightening
to many people. So, instead of saying “I’d like to see a little more inflation,”
an economist will say, “I am pursuing an expansionary policy” or “I am in
favor of quantitative easing.”
 |
| A Time Magazine cover from 1970. |
In today’s economic environment, the risk of excessive or
unmanageable inflation is very low. As stated in the
Harvard Political Review, “Quantitative easing aims to encourage
lending for the purpose of investment by pumping liquidity, namely cash, into
the financial markets. Analysts recognize that extra money, all else equal,
creates the risk of higher inflation, yet a low-interest rate environment like
the present may mitigate those risks (
source).”
Inflation reduces the real
value of the dollar (in terms of purchasing power) in relation to its nominal value (the amount printed on the bill). If a person has a fixed
rate mortgage, inflation is a blessing. Because the real value of the dollar has
shrunk, the real value of the debt has also shrunk (this also applies, by the way, to government debt, the real value of which shrinks when inflation increases). However, the creditor who holds
the mortgage is sorely discomfited by a shrinking dollar. To a creditor, other peoples’ debt is an
asset, and when the real value of debt decreases, wealth eludes the grasp of
creditors and comes into the hands of debtors. This is where austerity comes
in.
Austerity
When countries face uncomfortably high inflation (or the
threat of inflation), there is often a call for austerity measures. Austerity
measures consist of steps such as cutting public spending and services. The
phrase “cuts to public spending” means, among other things, putting people out
of work. When unemployment rises, spending decreases and the demand for goods
declines. Employees are willing to work for less money. Businesses and
creditors benefit.
Economists appear to agree that austerity is an effective
means of counteracting inflation. When members of government call for austerity
measures, it is vaguely troubling, because it betrays the fact that said
members of government are unaware of the fact that a state of austerity already
exists.
Austerity will always have its champions. And there is also
a natural constituency of people who would benefit from inflation. The trouble
is that the people who stand to benefit from inflation are generally not as
well-informed about economics as business-owners, politicians, and bankers. And
the economists who write columns and appear on TV are, in some cases, holders
of assets and will personally benefit if austerity measures are adopted.
Deflation
Even if his lackluster performance as Chairman of the
Federal Reserve gives little evidence of the fact, Benjamin Bernanke is a
formidable scholar in the field of economics. In his younger days, he was well
known for his writings on The Great
Depression. During the Great Depression, the Federal Reserve responded to
the decreased demand for money by reducing the supply of money. This is an
example of an austerity measure. Professor Bernanke believed that this action
by the Reserve made the Great Depression more severe, by bringing about a
situation known as deflation.
Not everyone agrees with Chairman Bernanke’s assessment.
Milton Friedman, for example, felt that the depression could have been averted,
if the Federal Reserve had avoided direct intervention and instead done more to
bail out failing banks. One of the
questions that had once distinguished Democrats and Republicans was this: is it
better to manage the economy centrally (as Keynes recommended), or is it better
to rely on “market forces” instead?
Today, Democrats and Republicans no longer represent the two
sides of this question. Instead, both parties have sworn allegiance to the
principle that market forces ought to be given wide latitude to steer the
economy. In support of this conclusion, consider the toothless regulations that
some politicians propose and others decry as being too strict. Consider also the
utter failure of political leaders to prosecute a single corrupt banker. This
may have something to do with the fact that Wall Street subsidizes both
political parties.
Regardless of disagreements over the causes of the Great
Depression, there appears to be a general agreement among economists that deflation
occurs when a reduced supply of money meets an increased supply of goods. In
this situation, the real value of the dollar will increase and the cost of
goods will remain low. In time, the market reacts by reducing production, and
this often leads to high unemployment. There is also agreement that, whereas
inflation can be managed, there is little that can be done about deflation (
source).
End the Fed?
Chairman Bernanke’s actions suggest that he would welcome
a modest increase in inflation. Indeed, he endorsed this policy when he was a professor
writing about the long deflationary period suffered by Japan during its
so-called “lost decade.” Yet, Bernanke publicly denies that he’s set a target
for inflation. One may infer, then, that he does not have a free hand to pursue
the policy that he thinks is best, or to pursue this policy as vigorously as he’d
prefer.
An article in the
New
York Times quoted an economist named N. Gregory Mankiw, who said, “If
Chairman Bernanke ever suggested raising inflation to, say, 4 percent, he would
quickly return to being Professor Bernanke (
source).”
Evidently, Mankiw believes that Chairman Bernanke is not entirely free to set
policy.
When speculating about who is able to exert influence over
Chairman Bernanke, it is important to acknowledge that there is supposed to be a
wall of separation that protects the Federal Reserve from political pressure. A
wall of separation is a good idea. Economists warn that political pressure on
the Federal Reserve can lead to disaster:
“Economic theory and massive amounts of empirical evidence
make a strong case for maintaining the Fed's independence. When central banks
are subjected to political pressure, authorities often pursue excessively
expansionary monetary policy in order to lower unemployment in the short run.
This produces higher inflation and higher interest rates without lowering
unemployment in the long term. This has happened over and over again in the
past, not only in the United States but in many other countries throughout the
world (
source).”
 |
| Theodor (Dr. Seuss) Geisel was a political cartoonist, among other things. He was alert to the risks associated with being too enthusiastic when leveraging the benefits of inflation. |
However, politicians aren’t the only ones who might be
tempted to exert influence over the Federal Reserve. According to the General
Accounting Office, during America’s recent financial calamity, the “Chief
Executive Officer of
JP Morgan Chase and
Co. served on the FRBNY [
Federal
Reserve Bank of New York] board of directors at the same time that his bank
participated in various emergency programs and served as one of the clearing
banks for emergency lending programs.” At about this time, the Fed supplied
J.P. Morgan with $29 billion to acquire
Bear
Stearns. The chairman of the FRBNY during the financial crisis was also a
board member and shareholder of Goldman Sachs. A director at the Federal
Reserve Bank of Minneapolis held stock in
Merrill
Lynch, later acquired by
Bank of
America (
source).
Another director of the FRBNY is a man named Jeffrey Immelt,
CEO of
General Electric and currently
President Obama’s “Jobs Czar.” Mr. Immelt is particularly notable, in that his
company did not owe any federal taxes in 2010 (
source).
Since taking over at
G.E., Mr. Immelt
has shed 34,000 U.S. employees while adding 25,000 employees abroad (
source).
Rather than launch into a discussion of the reasons why neither
the Democrats nor Republicans can be relied upon to fight back the corrupting
influence of monied interests on economic policy, a simple table (below) is
more eloquent than I could hope to be.
Campaign Donors and Their Largest Recipients
(www.opensecrets.org)
Goldman Sachs
Mitt Romney (R)
Barack Obama (D)
Kirsten Gillibrand (D-NY)*
Christopher Meek (R-CT)
Scott Brown (R-MA)**
|
J.P. Morgan
Mitt Romney (R)
Mark Warner (D-VA)***
Barack Obama (D)
Rob Corker (R-TN)****
Mitch McConnell (R-KY)
|
Bank of America
Mitt Romney (R)
Barack Obama (D)
Ed Royce (R-CA)+
Tim Pawlenty (R)++
Clark Durant (R-MI)
|
General Electric
Mitt Romney (R)
Scott Brown (R-MA)**
Christopher Murphy (D-CT)
Buck McKeon (R-CA)
John Boehner (R-OH)
Barack Obama (D)
|
* A leading opponent of legislation to prevent banks
from making highly risky investments( source)
** A Leading opponent of legislation aimed at imposing a
bank tax to offset the cost of bail-outs, as well as regulations designed to
limit investments in risky hedge funds and private equity funds ( source); also has a substantial investment in G.E. stock ( source)
*** Opposes increased regulation of banks, sits on influential Senate Banking Committee ( source)
**** Worried that J.P. Morgan's recent loss of several million dollars through reckless speculation might give Congress the "mistaken" idea that further regulation is necessary ( source)
+ Member of the Financial Services Committee that oversees mortgage lenders
++ When asked for his reaction to news that Bank of America paid no taxes in 2009, he responded, "taxes are too high." ( source) |
