[Viewpoint] Don’t forget the dangers of inflationIt may sound a little strange to hear someone worry about inflation in the midst of a global recession. One might say it is irrational to talk about inflation in a situation where the source of money has dried up and people have trouble selling goods.
After all, the entire world lived in fear of deflation until a short while ago. Haven’t governments lowered interest rates to rock bottom and poured in funds to revive the economy? That is true. And yet these solutions to deflation are calling back the ghosts of inflation.
The United States and the United Kingdom actually lowered interest rates to 0 percent in March, but money did not circulate in the market. Eventually, they instituted a quantitative mitigation policy.
The lofty term quantitative mitigation means the central bank directly pours money into the market. This is something the central bank, whose duty lies in stabilizing currency values and preventing inflation, would not normally dream of doing.
However, these are not normal times. The duty of the central bank is not important when the government is trying everything it can to save the national economy. Under the pretext of preventing deflation, central banks are now voluntarily stimulating inflation, their archenemy.
If the monetary policy of the central bank lies in increasing the money supply, it can be said that its financial policy is to circulate stagnant money artificially.
In place of a private sector that is suppressed by the bad economy, the government plays the role of investor and consumer. The problem is how it raises the necessary funds.
In a bad economy, there is no other way but to borrow money if the government has to spend more. Greater financial expenditure ultimately leads to the expansion of the financial deficit.
Once the national debt increases, however, it tends to grow like a snowball and it become difficult to repay the interest, let alone the principal.
Eventually a vicious cycle ensues in which the government obtains new loans to pay back old ones.
This is a moment of temptation to use inflation as a policy. Governments are tempted to think about lessening the burden of repayment by lowering the value of currency.
The hyperinflation in Germany in the 1920s, in South America in the 1980s and in Zimbabwe at the beginning of the 21st century are typical examples. Things are not yet that bad in Korea, but there is no guarantee it won’t creep up on us if the amount of government debt increases.
There are already big concerns about inflation in the U.S. and Britain, where huge amounts of government debt have accumulated.
Professor Nicholas Gregory Mankiw of Harvard University, who is well known for his economics textbook “Principles of Economics,” recommends that the U.S. government actively use an inflation policy to revive the economy. He says that as the recent economic slump is due to lack of demand, lower interest rates will increase loans to companies and home buyers. He also says that if this money leads to increased investment and consumption, it will ultimately increase the number of jobs. Everything he says up to this point is in the textbook.
However, Mankiw goes one step further. He says nominal interest cannot be lowered to less than 0 percent, but if inflation is fostered, the actual interest can be lowered to a negative figure. In other words, he prefers to choose inflation over rising unemployment rates and deficits.
But Mankiw’s proposal has a trap. The textbook hypothesis that investment and consumption will increase if inflation is stimulated is very different from the reality. The loads of money on the market caused by lower interest rates and greater spending is not directed to investment and consumption but to property markets such as stocks and real estate.
The inflation policy may encourage the real economy on the one hand, but it inflates a bubble in the property markets on the other. If the bubble continues to expand until the real economy recovers, inflation could get too high to control.
We could end up losing all our money due to inflation when we finally revive the economy.
In this respect, it is a relief that the Bank of Korea recently froze the prime rate. It appears not to have forgotten its duty yet.
The founder of the Russian Communist Party, Vladimir Ilyich Lenin, said, “The best way to destroy the capitalist system is to make its currency fall [through inflation].” Inflation is just as dangerous as deflation.
*The writer is an editorial writer of the JoongAng Ilbo.
by Kim Jong-soo