Saturday, May 22, 2010

How High Can Inflation Go...?

A student recently remarked to me that a 10 percent annual inflation rate in the US was “impossible.” Well, I invite anyone who shares this view to consider the US annual inflation rates between 1973 and 1982. Clearly, a 10 percent annual change in the US Consumer Price Index (CPI) is not only possible, it has happened! Moreover, the aggregate increase in the US CPI for the 10-year period 1973-1982 inclusive was approximately 85 percent (which I personally experienced following my graduation from high school in 1973). Oh yes, inflation rates of 10 percent annually and higher are absolutely possible…


Related Posts:

Using Inflation to Reduce Public Debt and Rout Entitlements

Repairing Sovereign Indebtedness: Get Ready

Using Inflation to Erode the US Public Debt

Implications of the Financial Crisis

6 comments:

Ron H. said...

The fact that the CPI only increased by 85% during this period is a real testament to the productivity gains experienced during the same period, as the total inflation was much higher.

Pat B said...

With regards to your Krugman post - the government is not full of dummies, but neither are big Wall Street bond traders. Inflating our debt 10% a year might have a laggard point of affliction, but would later be compensated for with the demand for higher rates. Would you please explain what you meant, unless, of course, I misunderstood you.

Dr William J McKibbin said...

Yes, if the government were to embark on indiscriminate monetary expansion for the next ten years, inflation would likely accelerate resulting in inflationary reductions in public debt and entitlements along the way. Moreover, as inflation accelerated, the US would probably be unable to continue borrowing at current levels because interest rates would rise to the point where virtually all of the US budget would be required for debt servicing. The net result of an extended surge in inflation would be to reduce the national debt, the costs of entitlements, and the scale of government spending overall, while curtailing the government's capacity to borrow -- make sense?

Of course, an extended period of double-digit inflation would also result in widespread unemployment and economic deprivations for most of society -- but then again, perhaps that's the point. The alternative methods for reducing the budget deficit are to impose spending cuts, tax increases, or simply default on the national debt, all of which carry equally ominious side-effects for our nation's economic well-being.

Once again, the aggregate US CPI between 1973 and 1982 inclusive was approximately 85%, so no one should presume to believe that extended periods of inflation are impossible...

Pat B said...

It's an interesting point that you make, especially since entitlement programs seem to be the fastest growing with regards to price inflation (senior living, medical costs, prescriptions, etc.). What would be interesting to see during this paradoxical period would be the sector afflictions, particularly for highly leveraged industries (banking, utilities, LBO firms). Since we're already going through a period in which the banking sector is recapitalizing quickly because of extraordinarily easy money policy, wouldn't there be a horribly perverse effect on the industry, particularly becuase of higher regulation? The point I am more interested in is how entitlement costs would also be affected, since they are, too a high degree, attached to inflation.

Pat B said...

By the way, it seems like you're implying that the government was printing money to create inflation during the 1970's, thus inflating the money supply. From what I understand, inflation during that period was caused by a price shock in oil which, noncoincidentally, caused a rapid rise in the price of commodities which, in turn, caused a rapid rise in general prices. The common misconception, if this is what you're implying, is that because Nixon initiated the fiat currency system in 1971, we were printing money and, thus, inflating the currency base, when in fact that has rarely ever even been implied based off of factual argument. People have tried to argue this for years with no proof EXCEPT the inflation rate. Inflation is horrible (although better than deflation) for the government because of the increase in borrowing costs. In this coincidence, because of what was happening in Iran and in other oil rich countries, price inflation was a coincidence caused by rapid price increases, rather than an inflation on the outstanding currency. Thus, by saying the government should just start printing money, "1970's style", you would be implying something with no evidence or factually based argument.

Dr William J McKibbin said...

Hi Pat, thanks additional comments. Regarding the 1970's, we had inflation because we had "too much money chasing too few goods" -- attributing the inflation to the Arab oil embargo and other oil cartel actions is one of the myths from this period -- thanks again for the comments, as always...

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