Good inflation | ZAWYA MENA Edition
PRINCETON – In response to recent concerns about the resurgence of inflation, US policymakers deny the existence of a threat and insist that expectations are “well entrenched”. They say any recent price spikes will prove to be temporary, resulting from one-off shortages that will be resolved when life returns to normal after the pandemic. Nonetheless, market participants and investors are increasingly fixated on the issue, and pundits are resentfully divided, with some denouncing those they disagree with as “cockroaches.”
Such rhetoric suggests a need to step back and think about what is meant by inflation and its opposite, deflation. Not all inflations or deflations are the same. Price drops (deflation) brought on by technical improvements can be good, as in the case of electric motors or chemical dyes in the late 19th century, or computers (and many other electronic consumer goods) in the late 19th century. Last 50 years. These are not the kind of price changes that lead to defaults and Great Depression-type debt crises.
Or consider a scenario where a different market response is required. Today’s rapid recovery has increased demand for freight transportation, pushing up fuel and energy prices. Additionally, a shortage of truck drivers and a ransomware attack on a major east coast pipeline left gas stations empty. But these shortages are the result of temporary problems. They do not portend a repeat of the oil shock of the 1970s.
Rising gasoline prices will signal consumers that it pays to reduce their fuel consumption and dependence on fossil fuels. This message aligns well with a broader recognition that the economy urgently needs to move away from carbon-intensive sources of energy. Once again, we must allow prices to fulfill their proper function of guiding consumer behavior and their future consumption plans.
These contemporary phenomena do not represent the type of inflation that would justify slowing down the recovery. The higher prices for chips and fuel simply reflect what producers and consumers need to do. As an impressively effective planning tool, the price signal is not an indicator to suppress, just as feverish patients should not be asked to put their thermometers in the refrigerator. Reading at high temperature provides the information needed to regain health.
Historically, major accelerations in globalization have often been accompanied by surges in inflation, each of which has led politicians and consumers to look for culprits. In the years 1850-1860, the rise in prices was interpreted as a response to the discovery of gold or to financial innovation following the development of new types of banking. In the 1970s, US monetary policy was largely responsible, although some also pointed to financial innovation (an increase in international bank lending) and the role of cartels in producing countries.
But the point is that in both cases the price effects helped trigger behavioral changes that ultimately led to efficiency gains and lower prices (âgood deflationâ). Therefore, it might be useful to view contemporary price increases as examples of âgood inflationâ, as they represent the first step in a useful and beneficial process.
Such a change in mentality would require breaking out of the consensus of the 1990s and 2000s, when inflation targeting became the key weapon of central banks in the quest for price stability. Governments and central banks around the world have come to a common understanding that an inflation rate of 2% – or perhaps 2.5% – (based on a consumer price index) is desirable. As a result, they began to worry whenever the rate moved even a few decimal places below (or above) that line, usually based on past horror stories about bad deflation (the Great Depression) or bad inflation (as in the world wars of the century).
This monetary policy consensus was appropriate for a stable world in which there had been no radical shocks for many years. One of its main advocates, then Bank of England Governor Mervyn King, aptly described the era when he coined the acronym NICE: Continuous Non-Inflationary Expansion.
But we are no longer in a NICE world. Today’s world demands dramatic behavioral changes, and the price mechanism is the most powerful tool we have for communicating how businesses and individuals should respond. The pandemic has dramatically accelerated the adoption of information and communication technologies, creating a need for greater investments to facilitate new global links and ensure efficiency and fairness. He also demonstrated how important collective action is in overcoming truly global issues, namely climate change.
When radical, society-wide changes in consumption patterns are both expected and desired, it is no longer appropriate to base policy responses on a simple price index. We need to allocate prices in a way that aligns with our common principles and priorities. For example, we should consider excluding from the calculation the prices of antisocial or unwanted products, such as fossil fuels and tobacco products. And we should be thinking of other metrics to help us measure how effectively societies and countries are responding to today’s defining challenges.
Harold James is Professor of History and International Affairs at Princeton University and Senior Fellow at the Center for International Governance Innovation. A specialist in German economic history and globalization, he is co-author of The Euro and The Battle of Ideas, and author of The Creation and Destruction of Value: The Globalization Cycle, Krupp: A History of the Legendary German Firm, Make the European Monetary Union and the next war of words.
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