Tuesday, March 01, 2016

Not Sure That's a Good Thing

Mark Toma links a piece talking about negative interest rates (tl;dr). I don't really care about the headline question but in the conclusion (quoted) they state:
The bottom line: international experience suggests that negative interest rates...will become a permanent part of the monetary policy toolkit. If that’s right, we need not worry quite so much whether a 2% inflation target is too low. [my bold]
That last part bothers me a lot.  From an economics standpoint the main reason that a 2% inflation target is too low may be that it does not allow enough room for monetary accommodation in the face of severe shocks.  The ability to use negative rates does, in fact, ameliorate that somewhat.  From a human welfare perspective, however, that makes things worse because it will allow very low inflation to no longer be seen as much as a problem.  Higher inflation (not 10%+ but more like 4.5%) has benefits beyond central bank monetary concerns.

The two big things are: it shrinks the value of debts, and (related) it encourages growth to outrun it.  If we can look forward to 4% inflation then that means any debt we take on today is smaller.  This means that student loans are not as daunting, and that a large mortgage will become more managable (it also encourages buying over renting, which, when not overdone, is a huge part of our potential economy).  It also means that businesses have a strong financial incentive to grow and build today: debt is better taken today than tomorrow, and even for debt free businesses, their giant piles of cash losing value at 4%/year doesn't look so good and should therefore be invested.

Of course modestly higher inflation does hurt one group of people: bankers/finance types.  Because of that, it's likely off the table anyway, but this reasoning will make whatever chance a higher inflation target had vanish.  That's not a good thing for our economy.

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