Monday, February 15, 2010

Krugman: Fight Stagflation with Hyper-Inflation

Paul Krugman is out with a "solution" to stagflation, although he doesn't mention the word, stagflation, so I don't think he realizes it.

As William L. Anderson points out:
[The] rule of thumb in examining anything Krugman says is to pay attention to his analysis of what is happening, but to ignore his Keynesian "solutions,"...
Krugman writes:
...the long-run Phillips curve isn’t vertical at very low inflation rates.
He is really describing stagflation here, but doesn't specifically state so. He is really saying that the way the Phillips curve is drawn, including in text books (see Mankiw, I'm sure), is wrong. Murray Rothbard understood the problem with the Phillips Curve decades ago, i.e. that the structure of the economy has nothing to do with the Phillips Curve.

In other words, at times you can have high inflation and high unemployment. There is one error that Krugman does make in his observation that the classic Phiilips Curve fails, and that is that it is not only occasionally "low inflation rates" where the Phillips curve isn't vertical, but anytime the monetary inflation rate is such that it continues to shrink the previously distorted capital structure. Thus, a monetary inflation rate of 25%, which would transalte into very high price inflation, could still result in climbing inflation, if prior monetary inflation was, say, 40%.

It's understandable that Krugman misses this extended point, since he has in writing stated he prefers (eating?) (contemplating?) banana fungus to attempting to understand distorted capital structures caused by monetary inflation.

That said, we must move on to what Anderson has warned us about, a Krugman solution to a problem. Krugman writes:
...when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis....So yes, let’s have modestly higher inflation...

But, since it is not low inflation, per se, but anytime there is a slowdown in monetary inflation from any previous higher (or stable) monetary growth that will cause higher unemployment, Krugman to be consistent must advocate higher inflation pure and simple to restore the previous unemployment structure. For example, in the late 1970's, we had double digit inflation and double digit unemployment (A period Krugman doesn't mention in his analysis--an inconvenient fact of the type Anderson reminds us he has a tendency not to mention). If Krugman really thinks that high unemployment is caused by "sticky wages", then his prescription in the late 1970's would have been even more inflation, bringing us pretty close to hyper-inflation. In short, Krugman is a banana fungus focused mad man.

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