Am I More Hawkish Than Ken Rogoff?

Short answer is, no. Long answer is, well, maybe: depending on what you call “hawkish”.

In a tour of essays since Excelgate, both Reinhart and Rogoff have been (finally) flaunting their dovish credentials: Reinhart telling us austerity is a disaster or Rogoff telling us that “austerity is not the only solution to a debt problem”. Or, perhaps most curiously, Rogoff calling for substantially more inflation:

One of us [Rogoff] attracted considerable fire for suggesting moderately elevated  inflation (say, 4-6 per cent for a few years) at the outset of the crisis.  However, a once-in-75-year crisis is precisely the time when central banks  should expend some credibility to take the edge off public and private debts,  and to accelerate the process bringing down the real price of housing and real  estate.

Structural reform always has to be part of the mix. In the US, for example, the bipartisan blueprint of the Simpson-Bowles commission had some very  promising ideas for simplifying the tax codes.

Now the second paragraph is obviously just fluff. It’s not vogue to write an op-ed without talking about “structural reform” and “simplifying the tax code”. It’s kinda like the chorus all Serious People must add to their argument to sound well-balanced.

And, quite successfully, Rogoff masks just how radical his original proposal is. It’s not the magnitude of “elevated [4-6 per cent] inflation” per se, rather the reason thereof. Left-leaning commenters, such as myself, have argued for more aggressive inflationary policies, but as a means to an end:

• In a liquidity trap, cash hoarding can put us in a deflationary spiral (Keynesian).
• Inflation, through the “hot potato effect”, increases money velocity and NGDP hence. (Market Monetarist).
• Wages (and prices, to a lesser extent) are sticky in the downward-direction and inflation is required for readjustment (Keynesian and Market Monetarist).
• Inflation will decrease the market-clearing interest rate and hence allow savers to substitute lending for money holding and increase investment (Mundell-Tobin effect).

We might call this inflation as a necessary means to an end. But Rogoff wants central bankers to consider “the option of trying to achieve some modest deleveraging through moderate inflation of, say, 4 to 6 percent for several years”.

We call that inflation as an end in and of itself. That is scary. And far more radical than anything I’ve ever proposed. For one, I don’t understand how more inflation by itself will bring down the “real price of housing and real estate”. It always seemed to me investment in land was a hedge against inflationary pressures. In fact, through the Mundell-Tobin effect, cheap mortgages should increase real estate demand – as we’re seeing today (albeit with substantially less inflation).

Scott Sumner puts this well in a fantastic argument for nominal income targeting:

Ben Bernanke does not really want higher inflation; it would be more accurate to say that he wants more aggregate demand and expects such higher demand to result in somewhat higher inflation rates. Unfortunately, however, the Fed has chosen a language to communicate its intentions that is both deeply unpopular and profoundly misleading. Inflation targeting gives the public the wrong impression, and the resulting political reaction impedes the Fed’s ability to carry out its work.

However, that’s only the tip of this dangerous iceberg. Inflation for the sake of inflation is a partial default on our obligations (aside from social security and TIPS, of course). I think debt forgiveness is a remarkably important component of the new international finance system. But it is a signal of fiscal irresponsibility and recklessness, neither of which afflict America today.

Our debt-to-GDP ratio is historically high, but nothing unsurmountable, especially at the low cost of capital today. The next decade is relatively stable as far as deficits are concerned, and there’s no reason to believe we won’t implement the necessary adjustments come what may after 2023. For this reason, inflation as a cop out of our obligations will send the wrong message:

• The Federal Reserve will loose credibility – that is, investors will forever think that we will inflate our way out of even tolerable debt burdens.
• The Federal Reserve will loose perceived independence – that is, investors will forever think that the FOMC will accommodate idiotic deficits and fiscal irresponsibility. (If they partially default today, imagine the expected reaction to real recklessness!)
• We will send savers the wrong message; inflation will cease to be a noble and necessary means to an end, but a counterproductive end by itself.

I actually don’t mind the distributional effects of inflation, by itself. Very few Americans save, and those that do at high levels should probably be taxed more. But I dislike the idea of incentivizing dissaving, especially as it becomes ever-evident that the poor can and should save more. America’s tax burden is rather low, which makes our debt eminently more solvable, and I would rather the distribution explicitly handled through a more progressive code (preferably a neo-Ricardian land value tax coupled with nationalizing oil & gas companies).

Notably, as a global reserve currency and store of value, devaluing the dollar for deleveraging’s sake is a terrible idea. Once the Federal Reserve looses credibility, the phantom bond vigilantes might materialize (I would be willing to take this bet, at low odds). This would impugn our ability to run high deficits for countercyclical stimulus come the next recession.

But I told you the short answer to the titular question is no. And that’s absolutely true. In fact, the pith of my argument against inflation is from deeply dovish roots: that is I don’t think our deficits are near intolerable. I think because the nominal average premium on long-run bonds is unprecedentedly low, the market is begging America to borrow more. If not for stimulus, for infrastructure and education. The only relevant arguments against any sort of deficit spending today is moral hazard.

I also support inflationary policy after considering DeLong and Summers (2012). If hysteresis contracts labor force and aggregate supply during disinflationary periods, the logical conclusion would be positive supply side effects of mildly higher inflation, even out of recession. (Indeed, the logic used therein derives from work by Larry Summers with regard to female entrance into labor markets during inflationary times). To this end, I would support the central bank dictating policy around the employment-population ratio, rather than unemployment rate.

Perhaps most flabbergastingly, why inflate so much when we can just target nominal spending? Your guess is as good as mine.