Just twenty years ago, economists and bureaucrats triumphantly proclaimed the apotheosis of macroeconomic stabilization policy. The “Great Moderation” saw a long spell of full employment, income growth, and low and steady inflation. How we long for those days now!
While labor markets appear healthy, this could quickly change. Meanwhile, inflation has surged: Consumer prices are up more than 8 percent, and producer prices more than 11 percent, from a year ago. We haven’t seen inflation this bad in more than a generation. Wages are rising, too, but not enough to keep up with inflation. American households are getting squeezed. Political unrest is increasing. And continuing global conflict will only make market turmoil worse.
It’s very tempting to return to the policy consensus of yesteryear. But that would be a mistake. While U.S. economic performance was admirable during the late twentieth century, it rested on a Faustian bargain: we accepted the harmful idea that economies needed some inflation—just a little bit—to grease the wheels. As a result, we put far too much power in the hands of unaccountable central bankers. Subjecting monetary policy to bureaucratic whims is one reason we experienced, in barely over a decade, a crippling financial panic and record-breaking inflation.
It’s time to set the record straight. We don’t need inflation to achieve full employment and economic growth. Dollar-depreciation economics just isn’t true. Furthermore, there are strong moral arguments against tolerating inflation. Descriptive economics and prescriptive political economy concur: When it comes to monetary policy, we need to fundamentally change the rules of the game.
Inflation doves claim dollar depreciation has beneficial economic consequences. Inflation increases investment by raising the returns on securities relative to highly liquid forms of wealth, such as cash or checking accounts. Furthermore, because inflation decreases real (purchasing power–adjusted) wages, it makes hiring workers easier. If central bankers keep inflation in the 2 percent range, they can supposedly give the economy a permanent shot in the arm.
Not so fast. Markets don’t work this way. These views rely on a permanently exploitable form of “money illusion,” whereby the public never gets wise to policymakers’ tricks. But even a passing conversation with American citizens reveals they’re well aware of when inflation happens and what it does to their earnings. Nor are they rubes when it comes to their investment choices. When we dig a little deeper, we see the inflation doves make two big errors.
Two Economic Errors of Inflationary Policy
First, inflation doves fail to recognize that investment returns respond to the dollar’s purchasing power. Interest rates on securities such as bonds have two components: the desired rate of return and a compensation for inflation over the duration of the asset. When markets expect more inflation, suppliers of capital demand higher returns. Demanders of capital are happy to oblige: paying more in depreciated dollars doesn’t sacrifice real purchasing power. This blunts the effects of inflation on investment.
It’s true inflation disincentivizes holding cash and other liquid forms of wealth. But if anything, this is a cost, not a benefit! As a tax on liquidity, inflation causes people to reduce their liquid wealth holdings, because these holdings rarely scale with inflation the way other securities do. Cash, of course, has no yield, so when inflation increases, holders of cash eat the entire dollar erosion. To the extent people try to avoid this stealth-tax, society becomes poorer. Having cash and cash-substitutes on hand is useful to meet regular transaction demands. Avoiding the inflation tax means people use up other resources, including time, to economize on liquidity. All those resources could have been put to some beneficial purpose in the absence of inflation.
The second error is a special case of the first. It merely happens in labor markets instead of capital markets. Just as investors are sensitive to their purchasing power–adjusted returns, workers are sensitive to their purchasing power–adjusted wages. People aren’t blind. They see prices rising at the car lot, the rental office, the gas pump, and the grocery store. Because we negotiate wages less frequently than other prices, inflation does lower wage values for a little while. But once people get wise and are free to renegotiate, they demand higher dollar wages to compensate for their lost purchasing power. Since employers are enjoying higher dollar incomes, they don’t mind paying higher dollar wages. But the dollar is cheaper than it once was. Net result: neither employers nor employees can afford more goods and services than before.
The persistence of dollar-depreciation economics is best explained by the prejudices of the political class, not the strength of its arguments. Many policymakers, including central bankers, believe the economy would flounder without their constant supervision and intervention. They exaggerate the problems with markets and—much more importantly—the efficacy of technocratic solutions. Yet there’s something more insidious than policy ineffectiveness going on here. If the only problem with inflation were that it didn’t work, it would be, at most, an irritant. This overlooks the moral aspects of inflation, which are grave indeed.
If economics is a science, political economy is an art. When we participate in public discourse, we’re not having a narrow economic conversation. We’re having a broad political-economic conversation. Value-free economics ends where value-laden policy proposals begin. And when we look at the values implicit in inflationary policy schemes, we see much that should offend us. To paraphrase the great Chicago political economist Frank Knight, we must grab the bull by the tail and stare the situation square in the face.
Inflationary Policy Fails Conventional Normative Tests
If, as we’ve argued, the positive economic analysis of low-inflation-as-shot-in-the-arm for the economy does not hold, what does that imply for normative judgment and prescription?
There are some who are unable to avoid inflation. As we noted, cash has no yield. Those who rely heavily on cash, such as the unbanked, are hurt the most by a depreciating currency. Who are these people? According to a 2019 Federal Deposit Insurance Corporation report, “Younger households, less-educated households, and Black, Hispanic, and American Indian or Alaska Native households were more likely to use [nonbank financial] transaction services, as were lower-income households and households with volatile income.”
Simply put: the poor with low credit, and especially minorities among them. Not only do their cash holdings suffer under an inflationary regime, but their relative lack of formal education—itself likely a reflection of broader social injustices—means they have less leverage with which to negotiate for better wages to compensate for eroded real incomes.
There is virtually no normative framework that justifies a policy regime that burdens the poor and marginalized. Since there’s no clear upside to inflation, its regressive effects are prima facie unjustifiable. Consider two of the most prevalent political-philosophical paradigms:
Rawlsian justice-as-fairness would say that from the “original position” behind the “veil of ignorance,” no reasonable person would favor an institutional arrangement that disproportionately hurts those at the bottom of our economy as does inflationary monetary policy. If one were to enter into this economy not knowing in what socioeconomic position one would start, no one would favor a system in which those at the margins of our society are handicapped against upward mobility by monetary policy. Yet this is precisely the barrier current policy places in their way.
Similarly, if the supposed benefit to investment is illusory, as detailed above, Pareto optimality would also come down in favor of monetary stability. Since market bargaining eliminates the supposed beneficial effects of inflation on investment and employment, the poor would gain and nobody else would lose if we could transition to a non-inflationary regime. Our current monetary framework is not Pareto optimal: by rejecting inflationary monetary policy, we could benefit one or more groups of people—in this case, the poor—without hurting others.
Toward a More Humane Monetary Policy
Yet both of these examples, while normative, are not quite moral. They are instrumental arguments, rather than intrinsic arguments, and thus neglect an important dimension of normativity. Morality has to do with what is best because it is good for its own sake. It is concerned with what is and contributes to the “good life” for human beings qua persons. Several interrelated moral perspectives add additional weight to our critique.
The personalist tradition, adopting Immanuel Kant’s second formulation of his categorical imperative, insists that persons, as rational beings, must never be treated as means to an end but always as ends in themselves with inherent dignity and worth. Imposing the costs of inflation upon the savings and incomes of the poor for the sake of an ephemeral—or worse, imaginary—economic stimulant effectively uses one group of people for the ends of another. The cash holdings of the poor may not be much, but those savings should be theirs to use as they choose, without being stealth-taxed by misguided inflationary policy with no justification in the common good.
Speaking of the common good, the Catholic tradition of social thought defines it as “the sum of those conditions of social life which allow social groups and their individual members relatively thorough and ready access to their own fulfillment.” Certainly, the capital and income needed for one’s livelihood fall within these categories. Furthermore, we cannot simply look out for our own interests, but through the principle of solidarity, “every social group must take account of the needs and legitimate aspirations of other groups, and even of the general welfare of the entire human family.” Thus, morally speaking, the inherent dignity of each human person not only serves as the foundation of individual rights but of our responsibilities one to another. Inflationary policy injures, rather than serves, the common good, and by the principle of solidarity people cannot overlook the harm done to others, even if it does not directly harm them.
There is a relation here to Kant, whose principle incidentally has ancient Christian antecedents and has been integrated into broader personalist social thought by figures such as the nineteenth-century Orthodox Christian philosopher Vladimir Soloviev or Pope John Paul II, among others. As Soloviev put it, “Pity which we feel towards a fellow-being acquires another signiﬁcance when we see in that being the image and likeness of God. We then recognise the unconditional worth of that person; we recognise that he is an end in himself for God, and still more must be so for us.”
So, too, on this personalist moral basis we must regard inflationary policy not merely as mistaken but, in a sense, inhumane. Indeed, this personalist ethic formed the anthropological foundation of the German economist Wilhelm Röpke’s Humane Economy: “I see in man the likeness of God; I am profoundly convinced that it is an appalling sin to reduce man to a means.” And Röpke, too, criticized inflationary policy along the same lines we have above, writing, “no great perspicacity is needed to recognize the close kinship between lack of respect for property and indifference to the value of money.” To the extent the poor often must rely on cash as a store of value, the two coincide. Inflationary policy lacks basic respect for the property of the poor.
Of course, public policy is always imperfect—morality is not reducible to law. But neither may law violate morality. Rather, as Thomas Aquinas argued, civil law must be based upon, while also striving to approximate, the natural moral law in the particular circumstances of our political life together. Likewise, our monetary policy ought to contribute to the common good, rather than detract from it as it does now.
A more responsible monetary regime isn’t about scoring partisan points, nor is it reducible to economic soundness. Good money does require good economics, but this isn’t sufficient. Rather, monetary stability is a matter of striving for a more humane economy, especially for the poor. Like all economic institutions, monetary institutions should enable all persons to flourish. As inflation ravages the U.S. economy, it’s clear our monetary policy—and the unaccountable technocratic-bureaucratic class that implements it—fails this basic test.