Debt

The Upside Of Inflation

Consumer prices rose by 3.6 percent over the past year, according to a report released this morning. That's higher than inflation's been over much of the past few years.

But according to some economists, inflation that's a little bit higher than usual may actually be good for the economy right now.

Here's why.

We often think of inflation from the point of view of people who have money sitting in the bank. Inflation means the value of their money is declining.

But for people who owe money to the bank, inflation means the value of their debt is declining. The faster prices rise, the easier it is to pay off debts.

That's because, in the long run, wages rise along with inflation. Between 1989 and 2009, for example, median household income rose from $29,000 to $50,000 before adjusting for inflation. After adjusting for inflation, median household income rose slightly over that period. In other words, wages rose a little bit faster than prices over two decades.

A key problem for the economy right now is the huge debt burden families took on during the credit bubble, particularly in the form of mortgages. While the debt burden has fallen from the peak it hit a few years ago, it's still high.

That debt burden is part of the reason people aren't spending more money, which in turn is part of the reason companies aren't hiring more people.

This process of paying down debt after a credit bubble — a process economists call deleveraging — is typically slow and painful. Higher inflation would speed the process by reducing the real value of debts.

Harvard economist Ken Rogoff has been pushing higher inflation for a while now. He recently wrote:

the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years. Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But, at the end of the day, such a transfer is the most direct approach to faster recovery.

For more: Listen to Robert Siegel talking to the NYT's Floyd Norris about how inflation helps debtors.

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