To Inflate or Not to Inflate…. That is the Question.

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There is a question that has been posed by a number of economists about the future of the economy after the recovery.  Will there be inflation because of all the money pumped into the economy by the government.  And there is a question currently posed by some economists as to whether we should actually stimulate inflationary conditions to accelerate our way out of a potentially long recovery period. It would help pay for the recovery and it would reduce the misery index.  Most economists probably otherwise see a recovery that will be both slow and long.

Some economists are supporting the idea of actually creating conditions for an inflation of up to as much as 6%. In our current situation, with unemployment effectively at 9% and prices a fraction of a point below zero, we would normally expect a rate of one to two percent as normal, non-inflationary growth.  So creating inflationary conditions of 6% would be dramatic…and some would say…dangerous.

The problem is that we saw in the late 1970s how difficult–particularly with this set of politicians–it would be to arrest a runaway inflationary spiral. It is very difficult with cooperating legislators. In the 1970s the Democratic Congress could not contain inflation with controls of any kind. Finally, when interest rates actually went to 21.5% and no one could afford homes or cars, Ronnie Reagan promised to kill inflation, keep unemployment low and balance the budget. He probably knew that he could not deliver on the latter two promises but was likely told by Paul Volcker that he had better stop the former or he wouldn’t have a Presidency at all…. just a nationwide shouting match.

As it turned out, Volcker put the brakes on the money supply and suddenly the bottom dropped out of everything. The recession that followed the inflation swallowed up huge numbers of businesses who were surviving on expensive money.  Unemployment did rise to double digits, and then it was over. In a couple of years people were able to buy houses again. Small businesses began to start up.

While Volcker, with Reagan courageously backing him all the way, dropped inflation from 12.5% in 1980 all the way to 3.8%…a remarkable achievement, it was not done without considerable pain. If you were to ask Paul Volcker, he would say that it is not something to which we should deliberately create again…ever.

The problem with inflation is that it is like booze and cigarettes. Lots of fun at the start but very difficult to give up. No one likes to take pay cut. And so no one does. And we had no politicians brave enough to suggest one. Volcker made it happen and lots of people had their jobs cut. But Reagan stood by him because Volcker persuaded him that the higher the inflation, the harder the adjustment.

But the Reagan tax cuts exacerbated the situation. Jobs and businesses were lost in the adjustment so the economy was down. Government spending on the other hand, particularly defense spending increased. So suddenly you have expenses of $1000 a month and your income goes to $400. How is that going to work out for you, do you think? It ain’t rocket science or even complex economics. It is simple arithmetic.

Thanks to Reagan’s brilliant idea of cutting taxes from about 70% for the top bracket down to…not 60% or 50% or 40%….but 28%. Genius. Huge deficits started immediately and took the national debt to over $2 trillion by the time Reagan left office. Annual deficits grew to as much as $340 billion under the first Bush. By the time the second Bush came along, the national debt…despite a very brief period of surplus under Clinton, was at $5.6 trillion and the Worst President in History added another $5 trillion to that in 8 years.

It is pretty clear why.  Increased costs of government.  Half the tax revenues as a result of huge tax cuts, and even then mostly for the wealthy. A sixth grader could figure out what would happen and it did. It was a stupid move by an unlearned President, and it cannot be denied because it only takes simple arithmetic, and you don’t need a financial calculator to figure it out.  You can do it in your head.