Friday, January 16, 2015

Below Target Inflation Means That Resources Are Being Wasted

Simon-Wren Lewis, and most economists, understand why deflation is bad for society.  Debtors will cut back on spending because they have to pay down their debt with more valuable currencies.  Creditors will not compensate by increasing their spending and we have end up with a level of aggregate demand that is below the level needed for full employment.  Lewis makes a further point.  he argues that we are also wasting resources when inflation is at 1% and the target is 2%.  There is nothing magic about zero inflation.  We typically have inflation when the demand for our economic output exceeds the supply of goods and services that are being produced.  That is, we are using all of our available resources but unable to satisfy demand.  We have unused and wasted resources as the rate of inflation falls.

Of course there is always a risk of excessive inflation. Wages usually rise when the demand for goods and services increases the demand for labor.  However, wage increases have been stagnant in much of the Western world for several years.  This implies that we have excess capacity, as well as unused labor.  We should be able to expand our economic, output and use our available resources, without the risk of inflation.  We know how to do that but there is much resistance to doing so because policy makers are more concerned about limiting the risk of inflation than they are about dealing with the problem of unused resources.  Lewis argues that their concerns are laughable.  They only justify a point made by Kalecki when he claimed that a full employment economy is not good for some people and that they will always efforts to promote full employment.

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