There are some difficulties and challenges inherent in this approach. First, inflating away debt is an act of redistribution from lenders to borrowers; creditors will oppose having their assets eroded. This anger might be blunted by reminding creditors that inflation also reduces the real value of the taxes they’ll have to pay to service government debt.
Second, hard-money advocates, including older economists who remember the high inflation of the 1970s, will fret that inflation could spiral out of control. This probably shouldn’t be a concern. The Fed has shown little difficulty in convincing the world that it’s committed to its 2% inflation target. As long as the Fed made it clear that 4% wouldn’t eventually become 6% or 8%, it would be able to hold the line at the new higher rate.
A third worry is that higher inflation could erode real wages. Theoretically, wages rise faster to keep pace with prices when inflation is high. But in the real world, this depends on worker bargaining power. And decades of weakened unions and rising industrial concentration have weakened worker power. The big overhang of unemployed workers in the coming depression will weaken it even further. The situation now is very different from the postwar period when strong unions and full employment made sure that wages kept pace.
So an elevated inflation target needs to be paired with higher minimum wages, policies to strengthen unions and other measures to encourage employers to raise pay. The government could even use wage-matching policies to raise pay across the board (rather than just for essential workers, as some now are proposing).
A final concern is whether the Fed could actually hit the 4% target. The Bank of Japan has been trying mightily to raise inflation for years with only modest success. If businesses don’t raise their prices in response to the Fed’s new target, inflation just won’t happen.
But it’s worth a try. Despite the challenges, a long period of 4% inflation could do a lot to simplify the intricate and complex web of debts that the U.S. economy built up in the years before the pandemic. A higher inflation target should be part of the policy menu for getting the economy back on its feet.
This article was provided by Bloomberg News.