Should we try to increase inflation to end the Great Recession?

This isn’t a normal recession. For one thing, the economic hole is absolutely huge (and was vastly underestimated by the government in 2008/9): we’re at 10% unemployment and even more people are underemployed. That alone makes it the worst economic catastrophe since the great depression.

The nature of the recession is also unique because it was precipated by a global financial crisis and skyrocketing public and private debt. This article, by David Leonhardt, argues that the recession is fundamentally about the bursting of a “consumer bubble.” Ezra Klein cites an economist who argues that we shouldn’t even call this a recession because the combination of the financial crisis and consumer debt makes it more like a “contraction.”

That’s a huge problem. A normal recession is basically a vicious cycle: consumers stop spending money, so industry stops producing as much goods, so industry starts laying off more workers, so unemployed workers stop spending money too, so industry stops producing even more goods—and so on. You can typically fix recessions by stimulating consumer demand (this was the purpose of the stimulus bill, both its tax cuts and its spending measures—to put more money in the hands of consumers).

But consumers aren’t using their tax breaks and spending income to buy goods; they’re using the extra money to pay down debt. On top of that, the government’s debt is huge and limits how much money we can pump towards consumers through tax cuts and stimulus spending anyway.

On the supply-side, corporations have made huge profits. But they’re simply sitting on the cash. They aren’t hiring, and they aren’t investing—because they know that consumers aren’t going to start spending money on their products anytime soon.

How do we get out of this mess? For a while I’ve just been advocating more stimulus. The debt is a problem we absolutely need to deal with—but the hole in our economy and massive unemployment is the more immediate problem. The stimulus act worked to fill that hole—not enough, because the hole was much bigger, but the concept worked. More stimulus would fill it further. Lowering unemployment is a bigger priority than paying down the debt (and we’ll never pay it down int he long term anyway with 10% unemployment).

But now I’m wondering (based on Klein’s post) whether another approach might work better. The problem of consumer debt can be helped by raising inflation. High inflation makes debt less of a problem—the money you owe has less value in the long term. It also forces corporations sitting on massive cash reserves to spend them now, which would stimulate the economy. Central banks can generate high inflation by increasing the money supply.

Obviously, high inflation can be extremely harmful if left unchecked, and it disfavors creditors who are owed money. But screw the creditors—they owe us after we bailed them out with TARP. And right now it’s pretty clear that the recession is a bigger problem than having high inflation, and I’d take the lesser of two evils anyday.