Stagflation Versus Hyperinflation

Paul Krugman: 

I’m a bit late to this, but Mike Kinsley has an odd piece in the Atlantic in which he confesses himself terrified about future inflation, even though there’s no hint of that problem in the real world. He’s not alone: there are a lot of voices predicting imminent hyperinflation in 2009, make that 2010 (and yes, I am keeping a record).

What I want to take on, however, is this piece of analysis in Kinsley’s piece:

Hyperinflation is when inflation feeds on itself and takes off beyond control. You can have stable 2 to 3 percent inflation. But you can’t have stable 10 percent inflation. When everybody assumes 10 percent, all the forces that produced 10 percent push it to 20 percent, and then 40 percent, and soon people are lugging currency in a wheelbarrow, as in the famous photos from Weimar Germany.

Uh, no — at least not according to textbook economics, which makes a real distinction between the kind of inflation that bedeviled the 1970s and 1923 (or Zimbabwe)-type hyperinflation.

Hyperinflation is actually a quite well understood phenomenon, and its causes aren’t especially controversial among economists. It’s basically about revenue: when governments can’t either raise taxes or borrow to pay for their spending, they sometimes turn to the printing press, trying to extract large amounts of seignorage — revenue from money creation. This leads to inflation, which leads people to hold down their cash holdings, which means that the printing presses have to run faster to buy the same amount of resources, and so on.

The kind of inflation we had in the 1970s, the famous era of stagflation — high inflation combined with high unemployment — was quite different. Deficits weren’t the issue — actually, US deficits were much smaller in the inflationary 70s than in the disinflationary 80s. Instead, what you had was a combination of excessively expansionary monetary policies, based on an unrealistic view of how low the unemployment rate could be pushed without causing accelerating inflation (the NAIRU), plus oil shocks that pushed up inflation across the board thanks to widespread cost-of-living clauses in contracts. There was never any risk of hyperinflation; the only question was whether and when we’d be willing to pay the price in high unemployment of bringing inflation back down.

Kinsley seems to be confusing the logic of the natural rate argument, which says that expected inflation gets built into price-setting, so you need an accelerating inflation rate to keep unemployment below the NAIRU, with the very different logic of hyperinflation, which is about people fleeing money.

Meanwhile, for those predicting hyperinflation, my question would be: what is it about the United States now that looks different to you from Japan in say, 2000? Big budget deficits and high debt? Check. Huge expansion in the monetary base? Check. And yet Japan’s GDP deflator has fallen 9 percent since 2000.

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