A recent New York Times articles notes the inflationary bias that some economists have at the Fed. President Obama’s nomination for Federal Reserve chair, Janet Yellen, would like to see inflation higher than it is today and some economists would like to see it closer to 6 percent to help increase companies’ profits, lower the real value of debts, and raise incomes. If a little more inflation is good, a lot more would certainly be better, right?
The false argument in this article misses the point that prices do not rise in tandem across all products in every location. Sure, the overall price level may rise, but many individual products-by definition-would rise by more or less than the national average.
The prices of goods that rise by more will send a signal to producers of those goods that they are profitable and increase production. The opposite is true for prices of goods that rise by less. This misallocation of resources by manipulation of the money supply (or subsidies and taxes) creates booms and busts throughout many markets and subsequently the macroeconomy.
We may enjoy the short-term benefits of inflation, but this will end in a worse situation than it began. The 1970’s and other episodes in the U.S. and around the world provide clear examples that this Phillips curve relationship (higher inflation leads to lower unemployment) does not exist, and in fact, it is costly for economic growth.
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