Governments Need Inflation, Economies Don’t

In an article in the UK’s Telegraph on October 10, veteran economic correspondent Ambrose Evans-Pritchard laid bare the essential truth of the nearly universal current embrace of inflation as an economic panacea. While politicians, CEOs and economists talk about demand stimulus and the avoidance of a deflationary trap, Evans-Pritchard reminds us that inflation is all, and always, about debt management.

Every year the levels of government debt as a percentage of GDP, for both emerging market and developed economies, continue to go higher and higher. As the ratios push out into uncharted territories, particularly in Europe’s southern tier, the ability to “inflate away” debt through monetization remains the only means available to postpone default. Evans-Pritchard quotes a Bank of America analyst as saying that even “low inflation” (not to mention actual deflation) is the “biggest threat to the dynamics of public debt.” IMF Managing Director Christine Lagarde ramped up the rhetoric further when she recently told the Washington Press Club that “deflation is the ogre that must be fought decisively.” In other words, governments need inflation to remain viable. It’s the drug they just can’t do without.  

But as this simple truth is just too embarrassing to admit, politicians and central bankers (and their academic, journalistic, and financial apologists) have concocted a variety of tortured theories as to why inflation is not just good for overly indebted governments, but an essential economic good for all. In a propaganda victory that even Goebbels would envy, it is now widely accepted that purchasing power must decrease for an economy to grow. 

Despite centuries of economic evidence to the contrary,they argue that if prices do not rise by at least 2% per year consumers will not spend, business will not hire, and economies will slip into an intractable deflationary death spiral. To prevent this, they recommend governments spend without raising taxes. Not only would such a move involve a direct stimulus by increased government spending, but the money printed by the central bank to finance the deficit will push up prices, which they argue is very healthy for the economy. As the Church Lady used to say, “How convenient.”