Motes vs. Beams
People, Dean Baker is quite a piece of work. He goes after people hard with what I will charitably describe as less than a fully correct analysis.
Here's another example, a post purporting to explain "Robert Samuelson's confusion on real interest rates:
In an economy operating below capacity, it would be desirably to have very low real interest rates to boost investment. This means that the cost of borrowing is low relative to the return on investment. Because interest rates can't go negative, it is impossible for real interest rates to fall as much as would be desired given the weakness of Japan's economy. It would be ideal if it could keep its nominal rates at their current near zero level, while inflation rose to 3.0 or 4.0 percent.
The other reason why inflation would be desirable is that it would allow homeowners to get out from under their debt burdens. If wages rose 3.0-4.0 percent annually in step with inflation, the burden of a fixed mortgage debt would be eroded through time. Also, if house prices rose in step with inflation, consumers would gain equity in their homes.
Excuse me for a moment.....
Thanks, now I feel a bit better. I think I may even be able to make a couple comments.
First, if the real rate is negative, then investment projects with a negative return may actually be "profitable". If the real rate is -4%, then a project with a -2% return "works". Strange way to rebuild an economy, no?
Second and more importantly, the most widely used model of the real interest rate is the Fisher equation which states that the nominal rate is equal to the required real rate plus a premium for expected inflation. It is beyond bizarre (but sadly not uncommon) to assert that inflation can rise significantly without nominal rates also rising.
Third, if inflation rose in a predictable manner, mortgage interest rates would rise as well (see point two) and there'd be no "savings" on new mortgages.
Fourth, to the extent that inflation was unanticipated, yes, borrowers would gain. But this is a zero sum game. Lenders, who after all are people, consumers, and voters too would lose an equivalent amount.
Fifthly and finally, as for how inflation builds home equity, all I can say there is WTF??? Housing is in the CPI. If all prices go up 3% how is the real value of your home increasing?
People, I am fine with trying a little bit of inflation here in the US of A. There are tons of idle cash sitting around, inflation is a tax on holding money, so maybe peoples will spend more. I don't think QE2 is the first sign of the apocalypse. But, even if it works to the specifications of its most ardent supporters, it's not going to come close to solving our problems.