Like corruption, crime, and asbestos, “inflation” is a word that many
Americans imagine in all-red capital letters, flashing across TV screens
amid warnings of crisis. For anyone who remembers the gloomy, scary
1970s, when the inflation rate in the United States reached double
digits, the word is shorthand for an economy that has spiraled out of
control, the dollar losing value and prices climbing feverishly.
“Inflation is as violent as a mugger, as frightening as an armed robber,
and as deadly as a hit man,” said Ronald Reagan in 1978, as nervous
citizens imagined the day when they’d have to push a wheelbarrow full of
cash to the grocery store in order to buy a loaf of bread.
That
particular nightmare never came to pass, thanks to drastic measures
taken by the Federal Reserve. For the better part of the past 30 years,
the dollar has stayed stable, reassuring American families and the
nation’s trading partners, with the central bank standing guard over the
economy and doing everything necessary to keep inflation low.
You
might say that Kenneth Rogoff has been one of the guards. As a research
economist at the Federal Reserve during the first half of the 1980s, he
helped ensure that the word “inflation” would never again flash across
American TV screens. His reputation as a conservative-minded inflation
hawk followed him from the Fed to the International Monetary Fund to his
current position in the economics department at Harvard.
But then
came the financial crisis of 2008, and the ensuing slump. And as the
economy has continued to stagnate, Rogoff, 58, has become the
flag-bearer for an unlikely position: that as we struggle to help the
economy find its way out of the darkness, inflation could be the answer.
It’s time, Rogoff says, to put Reagan’s “hit man” to work for the good
guys.
Over the past several years, Rogoff has emerged as one of
the world’s leading experts on the history of financial crises and how
they work, a unique perch that has given him a long view on what is
happening to our economy and what lies ahead. In the bestselling 2009
book “This Time Is Different,’’ he and Carmen Reinhart, currently a
senior fellow at the Peterson Institute for International Economics ,
laid out a detailed analysis of financial crises that have taken place
around the world going back 800 years, and they put forth an alarming
idea about our current predicament. What we’re going through, they
argued—what we’ve been going through ever since the subprime mortgage
crisis—has not been just a typical recession, as our leaders have been
treating it, but something much worse, something that demands
altogether different tools to stop it.
One
of these tools, Rogoff believes, is a temporary burst of inflation. And
for the past several weeks, as the stock market has convulsed and
debate raged over the Fed’s next move, he has been making his case
publicly, through syndicated opinion columns, high-profile TV
appearances, and numerous interviews. It’s an argument that Rogoff
himself admits is “radical,” and one he says he’d rather not be making.
But as he sees it, what’s holding the country back from recovery is not
just a lack of consumer confidence or suppressed demand, as in a normal
recession, but an immense overhang of debt: thanks to the collapse of
the real-estate bubble, millions of American families owe so much to
banks that they’re focusing all their energy on paying down their debts
instead of spending their money on new investments. There will be no
recovery until the painful process of working through that debt is
behind us, Rogoff argues, and an increase in the annual inflation rate,
which has floated around 2 percent since the early 1990s,would make it
easier for debtors to pay down what they owe.
“There’s
no penicillin for this,” he said in an interview. “There’s no quick
getting better. What you’re really talking about is taking the edge off
the downturn and coming back to normal growth somewhat faster.”
Rogoff’s
call to raise inflation has come under attack from several different
directions. Some economists think it wouldn’t do any good—that trying
to raise inflation wouldn’t create demand or spur growth the way Rogoff
thinks—while others believe that, given that prices actually seem to
be in danger of falling at the moment, the Fed couldn’t make it happen
if it wanted to. But perhaps the biggest problem for Rogoff is that, for
most policymakers, elected and otherwise, the idea of courting
inflation on purpose sounds downright crazy—not to mention politically
disastrous.
“Going around the country saying, ‘We need more
inflation’ is not going to be a big seller,” said Michael Mussa, a
senior fellow at the Peterson Institute and a former adviser to Reagan.
“Inflation means that the costs of everybody’s goods and services are
going up … And I believe it’s a substantial symbol of mismanagement by
the government and the central bank.”
Rogoff, however, remains
convinced that as the situation grows more desperate, our leaders will
feel pressure to start considering their options with more open minds.
“As more and more people realize that we’re not quickly going back to
normal,” he said, “they become more flexible.”
Though Rogoff speaks with unflinching steadiness, hearing him explain how
badly our leaders misdiagnosed the economy after the crash, one imagines
a doctor banging his fists against the door of a surgery ward, trying
to warn his colleagues that he has checked their patient’s chart and
realized they’re about to make a huge mistake.
The mistake we all
made, as Rogoff sees it, was thinking this was going to be nothing more
than a regular recession, the same kind of thing that has happened in
the United States once or twice every decade for the past 150 years.
These cyclical recessions come and go, and we have a pretty reliable
playbook for dealing with them: usually, an increase in government
spending and lower interest rates to encourage money to flow. Recessions
tend to end after about a year, at which point unemployment starts to
fall and normal growth resumes.
Far
less frequently, something more serious grips an economy: a financial
crisis that breaks the pattern, and from which it is much more difficult
to recover. Rogoff and Reinhart’s book suggests that such contractions
are characterized above all by severe, widespread debt, which leads to
long periods of economic stagnation and uncertainty. Rogoff puts our
current situation in that category, along with the Great Depression, and
he fears that if we do not act quickly and creatively to dig ourselves
out of it, we risk settling into a long-term slowdown along the lines of
what Japan has been going through since the 1990s. Mistaking this
crisis for a typical recession, he says, is like mistaking pneumonia for
a stubborn cold. “They’re very, very different animals.”
The
animal we’re wrestling with today, of course, was born of the vastly
overheated real estate market that collapsed in 2007, temporarily
paralyzing the global financial system and taking some powerful banks
down with it. Today, its legacy is a towering mountain of consumer debt,
government debt, and millions of underwater mortgages that are gumming
up the economy and preventing it from coming back to life.
“It’s
very unlikely that all these debts are going to get repaid in full,”
Rogoff said. Banks have loans on their books that people simply don’t
have—won’t have—the money to pay off, and expecting it to happen
means we’ll just stay frozen in place, waiting. What needs to happen,
Rogoff says, is “some transfer from creditors to debtors.” The ideal way
for that to happen, he says, would be through loan renegotiation,
whereby banks would forgive some homebuyers and strike repayment deals
with others. But that sort of piecemeal renegotiation has proved very
difficult to carry out.
A
more viable way to start fixing the nation’s balance sheets, Rogoff
argues, is by inducing a temporary bout of inflation. If the Federal
Reserve raises its target inflation rate by several percentage points—up from around 2 percent, where it’s been for the past decade, to
somewhere in the neighborhood of 4 to 6 percent—and injects new money
into the economy until it gets there, then debtors will get some relief
and the wheels of the economy will once again start to turn.
Rogoff
first laid out the argument for embracing inflation in one of his
columns in December of 2008—a move that came as such a surprise to
people who knew his reputation that he got letters from central bankers
who were sure they’d misunderstood him. Rogoff had worked at the Fed
under none other than Paul Volcker, whose mandate as Fed chairman was to
drive inflation down at any cost. Under Volcker’s watch, inflation fell
from 13.3 percent in December of 1979 to just 3.8 percent four years
later. And though Rogoff at the time was just starting out as an
economist—indeed, he was still transitioning from his first career as a
professional chess player—he soon became an intellectual force in the
movement to make central banks the economy’s first defense against
inflation. In 1985, he published what would become one of his most
widely cited academic papers in the Quarterly Journal of Economics,
arguing that healthy economies depended on central banks being reliably
committed to holding inflation down in all but the most extreme
circumstances.
Rogoff says he hasn’t changed his mind on how
central banks should behave, and still thinks our fears of runaway
inflation are well-founded. He just thinks that right now, it’s a risk
worth taking. “There’s certainly some benefit in a society having a
very, very strong conviction about keeping low inflation,” Rogoff said.
“But I think right now it’s not helpful. You can have a very strong
conviction that you don’t want to take medicines … And I respect that,
but there are times when there’s really no choice.”
Though
Rogoff’s idea about raising inflation has so far not gained much
purchase in the economics profession - Mussa, for instance, called it “a
hare-brained crackpot scheme”— he is not alone in his thinking.
Versions of the same call have been taken up by several prominent
economists across the political spectrum, including Olivier Blanchard,
the chief economist at the International Monetary Fund; Joshua Aizenman,
co-editor of the Journal of International Money and Finance; Harvard’s
Greg Mankiw, a former adviser to George W. Bush; and Paul Krugman, the
Nobel Prize-winning New York Times columnist.
THOSE
WHO disagree with Rogoff cite several key objections. One is that
inflation can be hard to stop once it starts: if the Fed turned on the
spigot, there’s no guarantee they’d be able to turn it off before
inflation got out of hand. Another objection is that if the Fed does
raise its inflation target, pumping more money into the system and
allowing the dollar to lose some of its value, lenders here and abroad
will lose faith in the currency and respond by raising interest rates,
which would ultimately make it harder for Americans to borrow money. A
third objection is practical: that even if the Fed tried to trigger
inflation, it simply might not be able to. The problem with the economy
right now, some critics say, is a lack of demand for workers and
products, and blowing air into the money supply would not change that.
“This
idea that there’s some separate policy instrument called ‘creating
inflation,’ I think, is a little problematic,” said Lawrence Summers,
the former secretary of the Treasury and Harvard president who also
served as the director of President Obama’s National Economic Council.
Increasing demand should be the primary goal, with inflation a possible
byproduct, Summers said. “I don’t think the idea that you could simply
get more inflation by saying you want more inflation is a promising
one.”
Rogoff is not swayed by these arguments. He emphasizes that
the level of inflation he is calling for is very modest—and that
there’s no really no reason to think that the Fed would be incapable of
inducing it or reining it in at will. As for damaging the central bank’s
credibility, Rogoff reiterates the extraordinary nature of the present
circumstances. “This is a very exceptional situation—a once in
Halley’s Comet kind of phenomenon,” he said. As he wrote in his column
earlier this month, “These are times when central banks need to spend
some of the credibility that they accumulate in normal times.”
Trying
to persuade central bankers to go for that plan involves a different
kind of problem: a political one. Inflation devalues the dollar and
makes things more expensive, making it an easy political target. Earlier
this month, as Wall Street and Washington waited to hear how the Fed
would approach monetary policy going forward, Texas Governor Rick Perry
more or less threatened Fed chairman Ben Bernanke with violence if he
“prints more money” before the next election. What he was talking about
wasn’t even inflation, but a policy called “quantitative easing,” in
which the Federal Reserve injects new money into the economy by buying
billions of dollars worth of Treasury bonds from banks. The Fed has
already tried this twice since 2008, and each time it has been
controversial. While Rogoff’s plan to raise the inflation rate target is
conceptually different from quantitative easing, it would involve the
same mechanism, and would push the same political buttons in an even
more extreme way.
Underlying
that opposition is more than just patriotism: it’s also a moral
objection. Transferring the debt burden from borrowers to creditors,
after all, effectively bails out borrowers by punishing the banks that
lent them money, as well as devaluing the savings of their more prudent
neighbors. That kind of rescue plan strikes many as fundamentally
unfair.
Rogoff understands this objection, and doesn’t dispute
that what he’s proposing is on some level unfair. But ultimately, he
argues, this contraction is dragging us all down together, and even
those lenders and savers will be better off if America’s debt overhang
is taken care of swiftly. Once that happens, and the economy starts to
recover properly, we’ll be able to focus on designing better policies
that will make us less vulnerable to financial crisis in the future. For
now, a little inflation might just be the cost of getting us to where
that might be possible.
“One way or another,” said Rogoff, “we’re going to be doing things we would not dream we would ever do before this is over.”
