The current inflation rate of 2 percent is "too low." That is at least if you believe Federal Reserve Chairman Ben Bernanke. With the economy growing "too slowly to bring down unemployment," Mr. Bernanke's solution is to increase inflation.
The Federal Reserve last week started printing up $600 billion to buy U.S. Treasury Bonds and another almost $300 billion to buy mortgages. The printing more dollars will reduce the value of the dollar just as doubling the number of apples will reduce the price of apples.
A falling value of the dollar is what is called “inflation.” The problem is that this "stimulus" will only temporarily reduce unemployment and get the economy growing by tricking people into making mistakes that they will later regret, mistakes that will cost the country much more in the long run than will be gained by these temporary improvements. With unemployment stuck at least at 9.5 percent for a record 15 months, the desire "to do something" is understandable, but the only people who this policy will help are the politicians currently in office.
You would think that all economists would have learned the lessons of the 1960s and 1970s: higher inflation rates only temporarily reduce unemployment. As the late Milton Friedman warned all the way back in his 1968 presidential address to the American Economic Association, the end result of those inflationary policies was just more inflation and unemployment. During the late 1970s, this phenomenon even had its own name: "stagflation." Mr. Bernanke seems to ignore the economic suffering that occurred when President Reagan had the courage to finally wring the inflation out of the economy in the early 1980s.
Unexpected increases in the inflation rate temporarily deceive workers into thinking that they are getting a better wage offer and lets companies hire workers at a lower real wage. Thus, unemployment is temporarily cut. Conversely, when the inflation is eventually wrung out of the economy, workers' wage increases in dollar terms will turn out to be less than anticipated with resulting increases in unemployment. Double digit inflation rates during the late 1970s were brought under control, but the cost was an unemployment rate that reached 10.8 percent.
Two percent inflation may seem "too low" to Mr. Bernanke (during the last three months inflation has actually averaged an annual rate of 2.8 percent), but inflation has real costs: it diverts businesses and people from making productive investments to making that protect them from inflation. Higher inflation rates are also much more difficult control.
With the next election no more than two years away, few politicians other than Reagan have been willing to bear the short-run electoral costs of reducing inflation. Let the next president face the higher unemployment rate from reducing inflation, they seem to say.
Besides only artificial short term gains on unemployment, the value of the dollar took a big hit on Mr. Bernanke's announcement. More inflation means that the value of dollar is lower, and foreigners immediately reduced how much they were willing to pay for them. Higher inflation also means that interest rates will rise, lowering bond and stock prices. One cost of higher inflation is the threat that it poses to Americans’ investments.
There might be another unstated explanation for increasing inflation -- more inflation will devalue the awful levels of our government debt, including the debt held by foreign countries such as China. If China bought Treasury bonds paying 3 percent interest and we can raise the inflation rate to 4 percent, the U.S. government will effectively make the Chinese pay us 1 percent per year for borrowing our money.
The economy is indeed growing "too slowly." But the problem is due to the chaos created by the stimulus as well as the disincentives created by higher taxes and increased regulations. The solution isn't more inflation. The solution is to end President Obama's job destroying economic policies.