Inflation isn't always evil

The Good Old Days!

"Welcome Inflation Now?" A prominent economist says yes - "a once-in-75-year crisis calls for outside-the-box measures." 

In our current debt-induced economic straits a higher inflation target will help solve some of the intractable problems of too many people owing too much money on undervalued assets:

In a column in The Financial Times this week, Ken Rogoff, the Harvard economist, suggested central bankers consider “the option of trying to achieve some modest deleveraging through moderate inflation of, say, 4 to 6 percent for several years.”

Mr. Rogoff conceded that “any inflation above 2 percent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s.”...

In an interview, Mr. Rogoff recalled how a parade of economists suggested to Japan that it seek to raise inflation to an announced target after its bubble burst, how Japan did nothing of the kind, and how it never really recovered. The Fed, he said, could make clear that it wanted some inflation and would buy Treasuries until it got that result.

“It has to be open-ended,” he said of such a program, not limited to a certain dollar amount of bond purchases, and it needs to be connected to a stated inflation target. The Fed chairman, he said, could say that “If and when inflation starts rising above the path I am aiming for, we will taper back bond purchases and raise interest rates to rein it back in.”

As it is, millions of mortgage loans secured by homes are worth far less than the loan amount. That keeps people from moving in search of better opportunities, and it removes an incentive for maintenance spending to preserve the value of the home. Many of those loans will never be paid in full, but there seems to be no route to a quick resolution...

The Fed has pushed down interest rates to extremely low levels. That means people who have good credit, and homes worth more than they owe, can refinance and save money. But others cannot. One minor step that the president might be able to take without Congressional action would be to require Freddie and Fannie to offer to refinance mortgages they own or have guaranteed even if the collateral is no longer worth what is owed. That would at least pass on some savings to homeowners in distress...

The chaos that has engulfed financial markets, with new rumors of European bank failures, arose as it became apparent that recovery was unlikely until something was done to write down bad debts, whether American mortgages or Greek government loans, or to make them good again by raising asset values and thus increasing the ability to repay.

And yet the anti-inflation warriors continue to fight old battles. There were three dissents from regional Fed presidents when the Fed promised this week to hold down rates for at least two more years. The European Central Bank has been raising rates on the belief that it must vigorously fight any sign of inflation.

In the future, central banks will have to realize that debt-financed expansions in asset prices can be a threat. For now, it would be nice if they would at least recognize that major deflations in asset prices can be much more important than the relatively small gains in commodities that show up in the Consumer Price Index.

From Floyd Norris, New York Times.