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Good Inflation

Economic horror stories from the Great Depression and the 1970s can offer useful lessons, but they are no longer appropriate for today's world. In a world undergoing radical economic, technological, and climatic change, we must recognize that not all price increases are the same, and that some are desirable – and even necessary.

PRINCETON – In response to recent concerns about resurgent inflation, US policymakers deny that there is any threat and insist that expectations are “well anchored.” Any recent price spikes, they argue, will prove temporary, arising from one-off shortages that will be resolved when life returns to normal after the pandemic. Nonetheless, market participants and investors are increasingly obsessed with the issue, and pundits are rancorously divided, with some denouncing those with whom they disagree as “cockroaches.”

Such rhetoric suggests a need to step back and think about what is meant by inflation and its opposite, deflation. Not all inflations or deflations are alike. Price declines (deflation) driven by technical improvements can be good, as in the case of electrical motors or chemical dyes in the late nineteenth century, or of computers (and many other electronic consumer goods) over the past 50 years. These are not the sort of price changes that lead to Great Depression-style defaults and debt crises.

The same distinction applies to inflation. There can be “good” price increases, as in cases where markets need a signal to produce a certain response. The current surge in the price of computer chips reflects a shortage of supply, which in turn is curtailing production of automobiles, refrigerators, and other products that rely on these components. But “Chipageddon” is not the end of the world. Rather, it is giving chip producers a clear signal to ramp up production and increase supply. Here, price increases are serving a useful role, and we can expect that chip prices will come down in the future.

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