David Frum

04.26.13

This Country Needs Inflation

"I am not a Marxist" is an old joke about what Karl Marx would say if he had lived to see the uses to which his ideas were put.

Inflations makes this number matter less (Getty Images) ()

This morning Carmen Reinhart and Kenneth Rogoff argue in the New York Times that they were never "Austerians," despite the uses to which their work has been put.

The politically charged discussion, especially sharp in the past week or so, has falsely equated our finding of a negative association between debt and growth with an unambiguous call for austerity.

We agree that growth is an elusive goal at times of high debt. We know that cutting spending and raising taxes is tough in a slow-growth economy with persistent unemployment. Austerity seldom works without structural reforms — for example, changes in taxes, regulations and labor market policies — and if poorly designed, can disproportionately hit the poor and middle class. Our consistent advice has been to avoid withdrawing fiscal stimulus too quickly, a position identical to that of most mainstream economists.

In some cases, we have favored more radical proposals, including debt restructuring (a polite term for partial default) of public and private debts. Such restructurings helped deal with the debt buildup during World War I and the Depression. We have long favored write-downs of sovereign debt and senior bank debt in the European periphery (Greece, Portugal, Ireland, Spain) to unlock growth.

But here's the most important point. The usual solution to unsustainable debt has historically been monetary, not fiscal: moderate inflation, like that which characterized the US economy between 1947 and 1969.

In the United States, we support reducing mortgage principal on homes that are underwater (where the mortgage is higher than the value of the home). We have also written about plausible solutions that involve moderately higher inflation and “financial repression” — pushing down inflation-adjusted interest rates, which effectively amounts to a tax on bondholders. This strategy contributed to the significant debt reductions that followed World War II.

In short: many countries around the world have extraordinarily high public debts by historical standards, especially when medical and old-age support programs are taken into account. Resolving these debt burdens usually involves a transfer, often painful, from savers to borrowers. (Emphasis added.)

That last sentence explains where conservative thinking has gone most wrong since 2009. Yes, we need to worry about the structural deficit. Yes, we need to reform entitlements, and especially healthcare spending (although "reform" should mean paying providers less, not abridging coverage; there's plenty of room to do that since Americans pay 60% more on average than their developed world counterparts for the care they receive).

But the key to the debt and growth problem is monetary. We need to reduce household debt across the board, especially mortgage debt and student-loan debate. Individual debt-adjustment programs are too slow and administratively complex. Moderate inflation - the 2% to 4% of the quarter century after World War II and then again of the 1980s - amounts to gradual debt relief. Yes, that's a tax on savers. But as we saw in the 1950s and 1960s and again in the 1980s, savers benefit too from a growing economy.