EconTech

I’ve heard from a lot of people railing against inflation always and everywhere. Mostly, these are people who seem to know very little about economics but continue to have very strong opinions about it (Ron Paul). Krugman explains one positive effect of inflation. But in all things, moderation.

In praise of expected inflation

Real rates go negative

There has been a lot of hand-wringing over the fact that interest rates on some TIPS — Treasury Inflation Protected Securities, which are indexed to consumer prices — have gone negative. It’s said to be a sign that inflation expectations are getting out of control. And it’s true that the implied 5-year rate of inflation has risen a fraction of a percentage point over the past few months.

But I think these worriers are missing the main point: mainly, what we’re seeing is an economic environment so weak that real interest rates need to be negative for a while. Why “need”? Well, the decline in medium-term interest rates could be pronounced excessive if anyone expected lower rates to produce a runaway boom — but nobody expects that. In fact, the question is whether falling rates will even be enough to offset the effects of slumping investment demand and consumer spending.

And given that a negative real interest rate is necessary, we should be thankful that it’s possible. If we had come into this slump with zero expected inflation, we’d be up against the zero lower bound right now. It’s only because we had an inflation buffer that the Fed even has a chance of avoiding a Japan-type trap.

So let us all praise expected inflation. Without it, we’d already be in deep sushi.