A reminder of a few basics about inflation, and why a "crazy" move is being considered and not necessarily rejected ..... at least not by everyone.

Thursday 16th June 2016

  

A reminder of a few basics about inflation, and why a "crazy" move is being considered and not necessarily rejected ..... at least not by everyone.

ref :- " Can helicopter money boost inflation or is it just a flight of fancy ?" by Oliver Kamm, The Times , Business Comment

We're always hearing about it, and it's a problem right across the developed economies of the world : Inflation , or rather the lack of it. You could be forgiven for wondering whether near-zero inflation (and occasionally deflation) is a cause or an effect of any nation's economic woes .... the answer is it's both, and an excellent example of a vicious circle if ever there was one : poor growth and lack of demand fosters a lack of price pressures (or inflation), whilst a future that promises stagnant prices discourages both investment by corporates and spending by consumers, which of course brings us back to poor growth and a lack of demand.

Generally speaking, central banks in the major developed nations have set themselves a goal of "at or near, but not exceeding" 2% inflation  -- a target that all have missed and some by a wide margin. The substantial drop in commodity prices since Summer 2014 can explain some of the shortfall, just why such historically loose monetary policies in the US, the Eurozone, Japan and the UK have failed to produce any meaningful pick-up in price pressures has got the central bankers scratching their heads.

So apart from the more obvious reasons already mentioned, why is some measure of inflation important, and just how much of it do we want ? Plainly, high inflation is a No-No and it's not difficult to see why. Rather than refer to everybody's favourite and entirely extreme example of Zimbabwe and their estimated peak inflation rate of 79.6 billion per cent (yes, really) in November 2009, Mr Kamm offers us current-day Venezuela. There, the IMF estimates that inflation will hit 720% by year-end and it threatens to wipe out the middle class by making their savings worthless. As ever, the wealthy with access to smart accountants and offshore facilities are likely to be protected from the worst of it.

It's less easy to be certain about the net economic costs of low or moderate inflation, which for the sake of this argument is described as up to 10% (although thoughts of a rate towards the top of that range might have those with longer memories wincing a bit). The argument goes that the main cost of low or moderate inflation is not so much economic as a problem in the tax system. If tax bands are not indexed to inflation, nominal earnings growth will push people into a higher tax bracket which will reduce their real (or net) income and therefore consumption. It's called Fiscal Drag.

As a fiscal issue, as opposed to a monetary one, it does not come under an independent central bank's remit and would have to be addressed by politically-led Treasury / Finance ministries. Overall, and certainly from a central bank's point of view, low or moderate inflation doesn't reduce purchasing power as it's a rise in all prices (and by extension incomes) rather than a shift in relative prices. Importantly, it also erodes the value of debt  --  if there's no inflation, consumers may rein back spending as their debt burden isn't falling.

So SOME inflation is desirable, but how are central banks going to conjure some up ? These historically easy monetary policies haven't worked up to this point but it's possible that more of the same will be tried. The trouble is, nobody really knows what the long-term effects of negative rates for example might be (not good, in many people's opinion), and in the case of the ECB how much further can you expand a Quantitative Easing programme that is already having diminishing returns ?

One radical option that we've talked about before (though never really believed was truly viable) is Helicopter money  --  direct cash transfers to consumers. The very thought is still enough to make the more conservative analysts break out in a sweat but it's still being discussed. If QE was considered a bold move, at least in principle it could be reversed by the central bank selling previously purchased assets and consequently reducing the money supply. Helicoptering money, by definition, would entail a permanent expansion of the monetary base.

But could it work ? Yet again, nobody knows. Those against adopting such a policy (and there would be many) would probably argue that such a radical move would signal desperation and frighten would-be consumers into hoarding the cash rather than spending it as was intended. In the end however we keep coming back to one conclusion :

Central banks CANNOT do it all alone through monetary policy. Those that can have to play their part by implementing an expansionary fiscal policy. In Europe, top of the list must be Germany. We know that Germany is a cautious nation, but when the cost of capital is so cheap and infrastructure so neglected, the argument for fiscal stimulus is growing ever stronger.