Why Are We All So Obsessed With Inflation?

Paul Krugman brings up a familiar trope this weekend: why is it that everyone is so obsessed with ultra-low inflation, even in the middle of a sluggish economy that would almost certainly benefit from a few years of 4 percent price growth? His answer: rich people are uniquely vulnerable to high inflation, and therefore fear it. And since rich people have tremendous influence on policy—especially economic policy—we’ve consistently implemented policies dedicated first and foremost to restraining inflation. Tyler Cowen dissents:

We all know that inflation is extremely unpopular with voters.  We also observe that inflation remains extremely unpopular in a variety of northern European economies, which typically have more egalitarian distributions of income (though not always wealth) than does the United States.  In any case the top 0.1 percent in those countries has less wealth per capita than in the U.S. and, at least according to progressives, less political influence too.

….People that wealthy can put their money into hedge funds, private equity, private capital pools, and the like….The very wealthy also have the greatest ability to hedge against inflation using derivatives and commodities, if they do desire….I am not suggesting that the very wealthy are out there pushing for higher inflation. But they are much more protected against such inflation than Krugman’s analysis suggests, and the middle class in protected service sector jobs is more vulnerable than is usually recognized.  There is a reason why 4-6% price inflation has become the new third rail of American politics.

I chalk this up to something a little different: inertia. Practically speaking, I don’t think protected service sector workers have a lot to fear from moderately high inflation. They’re mostly unionized, and their contracts often include COLA hikes. But I agree that rich people don’t have a lot to fear either. Given modern portfolio management, it’s not hard to hedge against inflation, especially if you’re wealthy enough to pay a good money manager. The elderly are often brought up in this context too, and they probably really do have a certain amount of vulnerability to inflation. But not that much. Social Security benefits are indexed to inflation, and even most middle-class investments (in 401(k)s, etc.) tend to be inflation-resistant, if not inflation-proof.

So what’s going on? My take has long been fairly simple: it’s mostly due to septaphobia, or fear of the 70s. It’s not actually true that the middle class was decimated by the 70s, but a lot of middle-class workers felt hard done by, especially since the price we all paid for the 70s was the traumatic Volcker recession of 1980-81. As for rich people, they really did suffer losses during the 70s as we made our rocky transition from an era of financial repression and fixed returns to our current era of global finance and variable returns. Central bankers belong in this story too: during the 70s, they developed a deep fear of their own inability to control wage-price spirals once inflation got above 2 percent or so. This fear is badly misguided, however: the economy has evolved enormously since the 70s and modern central banks have plenty of tools to fight inflation before it gets out of control. Basically, the 70s are to modern publics what Weimar hyperinflation was to a generation of Germans: a scarring experience that forged a deep and broadly-held fear of inflation of any kind.

There’s so much inflation indexing in our modern economy—sometimes explicit, sometimes not—that inflation poses only a moderate threat to the rich. In fact, if I had to choose a class of people who probably should be threatened by inflation, it’s the broad working and middle classes. After all, why do so many economists think a higher inflation rate would be good for the economy? Partly because it produces lower real interest rates, and thus stimulates investment. However, it’s also because it allows a faster downward adjustment of real wages, since employers can simply let inflation erode wage rates instead of angering workers with deep nominal cuts. And who does that affect? Not Bill Gates.

That said, I don’t disagree that, in reality, elite opinion drives much of the inflation fear in the United States and Europe. It’s irrational, since the rich benefit from lower middle-class wages and a faster-growing economy, but that doesn’t mean it’s not real. Phobias are hard to cure.

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