Which would you prefer — rising unemployment or inflation?
That is the question, posed and answered, by Harvard economics professor N. Gregory Mankiw in a recent New York Times commentary. Mankiw was an adviser to President George W. Bush.
Inflation is what the professor prefers, and the Federal Reserve can produce it, he says. Why? Because inflation would allow a negative interest rate.
Right now, the Fed is targeting zero and can’t go lower. But inflation creates the effect of lower rates.
“While nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative."
With real interest rates at negative values, the economy would come back life, Mankiw says.
"If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend," Mankiw argues.
Mankiw urges Fed chairman Ben. S. Bernanke to make a commitment to higher inflation although Bernanke has previously been an advocate of inflation targeting. Most central banks have a legal mandate, be it price stability or employment, but usually not both.
"A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations," according to Mankiw,
"Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy," he says.
"But there are worse things than inflation...[and] we have them today."
Inflation, according to many other economists, is poised for an upturn because of the huge U.S. debt and the cost of servicing it, let alone paying it down.
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