Bryan Caplan  

Another Deleted Scene from MRV: The Benefits of Overestimating the Dangers of Inflation

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Here's another section that didn't make it into the final draft of my book:

Mutual cancellation of errors does happen on occasion. Beliefs about inflation are my favorite example. Most economists who tally the costs of inflation conclude that - at least at moderate levels - the public seriously overrates its costs. According to Alan Blinder, "[I]nflation, like every teen-ager, is greatly misunderstood . and... this gross misunderstanding blows the political importance of inflation out of all proportion to its economic importance." To stay in office, politicians have to be "inflation hawks," even though the employment costs of the war on inflation dwarf the benefits.

But Blinder overlooks counter-balancing errors. Most obviously, there is the public's anti-market bias. People tend to blame inflation on private sector greed instead of macroeconomic . and especially monetary . policy. The self-styled "enemies of inflation" often do more for their popularity by lashing out at scapegoats - profiteers, speculators, the black market - than overselling tight money. Declaring war is one thing; targeting the real enemy is another.

Another factor that offsets the public's overestimate of the cost of inflation is its tendency to see the benefits of inflation as permanent. This is a subtle mistake; Blinder admits that leading Keynesian economists made it for quite a while: "[T]he 1960's view that stabilization policy can push the economy toward permanently lower unemployment, albeit at the cost of permanently higher inflation, is gone forever . banished by both a powerful theory and persuasive evidence." Modern financial news suggests that this important insight has scarcely trickled down to economic journalists, much less the general public. Imagine how the economy would look if the public knew the true cost of inflation but saw its benefits as permanent. Inflation would be higher, and everything else would be about the same. So the inflation paranoia that Blinder bemoans is, at least in part, a blessing in disguise. It makes us less likely to raise inflation in a futile effort to eliminate unemployment once and for all.


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Jennifer writes:

I agree that the public does not have a good or even respectable understanding of inflation. I also agree that a balance "acceptable to the public" between inflation and unemployment rates isn't possible. The monetary policies put into place to take care of one counteracts the other causing it to increase. The public just needs to decide which they care about more, inflation or unemployment. I do believe that there can be some sort of balance where there is some inflation and unemployment but the constant shifts in the market leave that to be a very short time. Unless the Fed can learn to predict, and predict with accuracy, the way the market will shift I think that the "balance" between the two is only false hope.

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