E Larry Kudlow’s Strange Views About Inflation

Larry Kudlow, well known economic pundit for years on CNBC, has unusual views regarding inflation. Through a Forbes article, we see that he spoke to the Heritage Foundation and said this:

Inflation is a devastating tax on savings. But low inflation is a tax cut. By enhancing the value of financial assets, price stability rewards patient savers and investors. It is a stimulant to capital formation, new business start-ups and growth. Growth does not cause inflation, low inflation causes growth.

That does not seem quite right. After all, when there is growth, auto prices go up, and when growth is slow, there are discounts and rebates on houses. The same sort of thing works for homes. The builder throws in upgrades that normally cost extra, and if that doesn’t work, the price of new homes trend lower. 

Kudlow is right about inflation being a tax on savings over time. It certainly hurts those on fixed income if the COLA’s do not exceed the inflation. And manipulation of cost of living indexes almost insures that COLA’s do not help as much as they should. 

But low inflation has not exactly driven massive growth, and Kudlow would have a hard time making that case. In discussing this issue it is necessary to define the natural rate of interest as a neutral rate, where gluts don’t appear and shortages don’t appear. If rates are too low, shortages of real products appear. If rates are too high, an overabundance of real products gluts the markets. 

However, in credit, in the price of credit, the central banks set the rate of interest. It is hard to know if they are getting that rate right. Will credit be too abundant or too tight? Certainly the natural rate of credit being lower than the Fed ‘s funds rate will cause big problems. 

 As I wrote on a personal blog post:

[David] Beckworth shows us a study done by MIT,  Harvard and U.C. Berkeley by economists Caballero, Farhi and Gourinchas, which shows that central banks cannot push natural rates (r*) too far negative. The article is titled Safe Assets and Aggregate Demand. The failure of central banks to push rates lower results in an interest rate gap emerging, which will cause output to fall below its potential. This impact on aggregate demand has slowed the normal business cycle. By the way, the economists say that physical assets are simply not safe assets.