Bernanke vs Krugman: Does inflation create more jobs?
Will the American economy create more jobs if inflation were higher?
Nobel Prize-winning economist Paul Krugman thinks the US should be prepared to tolerate higher inflation if it wants to cut the unemployment rate and get the listless economy moving again.
In a widely-reported column in The New York Times, Krugman berated US Federal Reserve Chairman Ben Bernanke for not doing enough to tackle the problem of high unemployment. "While the Fed went to great lengths to rescue the financial system, it has done far less to rescue workers," Krugman wrote. "Higher expected inflation would aid an economy" because it would persuade investors and businesses "that sitting on cash is a bad idea," Krugman said in his column, adding that the Fed should attempt to send inflation to 2 percent temporarily.
Moreover, such a policy shift would be in line with Bernanke's comment in 2000 that the Bank of Japan should pursue faster inflation to escape deflation, he said. Krugman also said he thought what the Federal Reserve was doing now contradicted Bernanke's earlier academic work.
Bernanke, of course, doesn't agree. He doesn't think letting inflation rip will create jobs.
"We, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we've been able to take strong accommodative actions in the last four, five years," Bernanke told reporters, according to Bloomberg. "To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do."
He also refuted the contention that there was a difference between Bernanke, the academic who urged Japan to inflate, and Bernanke the central banker, who does not want to stoke inflation. He said: "...there's this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies...That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time."
Bernanke said the main difference between Japan's economic slump 15 years ago and the US today is that Japan was in deflation and the world's largest economy isn't.
And pumping up inflation as a policy response to slow growth or high unemployment is rarely a good idea, especially because inflation, once unleashed, is always difficult to control. No wonder Bernanke termed Krugman's advice "reckless".
Krugman, though, might need to make a trip to India to understand why Bernanke is right about not messing with inflation in the hope that it will create jobs.
We invested in workfare (NREGA, etc) and got inflation. We threw money at the poor and still got inflation.
Inflation has been steadily rising over the past few years in India. In 2011, for the most part, it stayed stubbornly above 9 percent. Even in the current financial year (2012-2013), most experts are betting inflation will stay at 7.5-8 percent.
What have we got in return for tolerating higher inflation? Certainly not jobs growth. As this Firstpost story using research agency Crisil's data notes, in the second half of the past decade, the economy created all of 2.2 million additional jobs despite all the welfare spending, while the first half created as many as 92.7 million new jobs.
Interestingly enough, the economy grew by 6 percent on average between 1999-2000 and 2004-05, while it revved up to 8.6 percent in the next five years. That means even as India experienced higher growth, the employment potential of sectors did not rise. In this case, higher growth did not equal more job opportunities.
In fact, the government's huge social spending programmes caused a dramatic shift of people from self-employment to government welfare in the five years to 2009-10. As the story notes, the category of self-employed people fell by a dramatic 25.5 million during the second half of the decade - equal to the number of people who had joined NREGA-based projects by the end of 2010-2011.
Making matters worse, India is now stuck with structurally high inflation, which is pushing future growth rates lower. India's long-term trend growth rate - the rate of growth achieveable without pushing up inflation much higher - has now come down to 7 percent from 8-8.5 earlier. We have tolerated inflation all right - but it hasn't given us much in terms of more jobs or better economic growth for the future.
Sure, the US is a far more responsive economy compared to India, where structural rigidities in labour prevent additional employment generation in the organised sector. But Americans are busy paying down the debts they accumulated over the last 10 years. Companies are sitting on cash because they are also saving for a rainy day - in case it comes again.
The cycle of debt paydowns will have to bottom out before consumer spending starts rising again. That's when companies will let go of their cash and start investing.
Wonder why Krugman thinks inflation is going to make companies invest or hire more. America does not need more artificial boosters when it is already on monetary steroids.
Find latest and upcoming tech gadgets online on Tech2 Gadgets. Get technology news, gadgets reviews & ratings. Popular gadgets including laptop, tablet and mobile specifications, features, prices, comparison.
As the Federal Reserve nears a decision to pare its bond-buying program, top policymakers on Thursday turned to a new monetary policy battlefront: a growing debate over how the Fed should signal the timing of eventual interest rate hikes.
The question to ask now is by how much will the RBI cut the repo rate by, as and when it does start to do so.
It is the first time that the central bank projected that far ahead into the future. While financial markets cheered at the prospect of cheap money for the next three years, what does it mean for the rest of the world?