Naked Economics Wheelan, Charles (books to read for 13 year olds TXT) 📖

the bigger the buffer. On the other hand, if a central bank proves that it is serious about preventing inflation, then the buffer gets smaller. One of the most significant benefits of the persistent low inflation of the 1990s was that lenders became less fearful of future inflation. As a result, long-term interest rates dropped sharply, making homes and other big purchases more affordable. Robert Barro, a Harvard economist who has studied economic growth in nearly one hundred countries over several decades, has confirmed that significant inflation is associated with slower real GDP growth.

It seems obvious enough that governments and central banks would make fighting inflation a priority. Even if they made honest mistakes trying to drive their economies at the “speed limit,” we would expect small bursts of inflation, not prolonged periods of rising prices, let alone hyperinflation. Yet that is not what we observe. Governments, rich and poor alike, have driven their economies not just faster than the speed limit, but at engine-smoking, wheels-screeching kinds of speeds. Why? Because shortsighted, corrupt, or desperate governments can buy themselves some time by stoking inflation. We spoke about the power of incentives all the way back in Chapter 2. Still, see if you can piece this puzzle together: (1) Governments often owe large debts, and troubled governments owe even more; (2) inflation is good for debtors because it erodes the value of the money they must pay back; (3) governments control the inflation rate. Add it up: Governments can cut their own debts by pulling the inflation rip cord.

Of course, this creates all kinds of victims. Those who lent the government money are paid back the face value of the debt but in a currency that has lost value. Meanwhile, those holding currency are punished because their money now buys much less. And last, even future citizens are punished, because this government will find it difficult or impossible to borrow at reasonable interest rates again (though bankers do show an odd proclivity to make the same mistakes over and over again).

Governments can also benefit in the short run from what economists refer to as the “inflation tax.” Suppose you are running a government that is unable to raise taxes through conventional means, either because the infrastructure necessary to collect taxes does not exist or because your citizens cannot or will not pay more. Yet you have government workers, perhaps even a large army, who demand to be paid. Here is a very simple solution. Buy some beer, order a pizza (or whatever an appropriate national dish might be), and begin running the printing presses at the national mint. As soon as the ink is dry on your new pesos, or rubles, or dollars, use them to pay your government workers and soldiers. Alas, you have taxed the people of your country—indirectly. You have not physically taken money from their wallets; instead, you’ve done it by devaluing the money that stays in their wallets. The Continental Congress did it during the Revolutionary War; both sides did it during the Civil War; the German government did it between the wars; countries like Zimbabwe are doing it now.

A government does not have to be on the brink of catastrophe to play the inflation card. Even in present-day America, clever politicians can use moderate inflation to their benefit. One feature of irresponsible monetary policy—like a party headed out of control—is that it can be fun for a while. In the short run, easy money makes everyone feel richer. When consumers flock to the Chrysler dealership in Des Moines, the owner’s first reaction is that he is doing a really good job of selling cars. Or perhaps he thinks that Chrysler’s new models are more attractive than the Fords and Toyotas. In either case, he raises prices, earns more income, and generally believes that his life is getting better. Only gradually does he realize that most other businesses are experiencing the same phenomenon. Since they are raising prices, too, his higher income will be lost to inflation.

By then, the politicians may have gotten what they wanted: reelection. A central bank that is not sufficiently insulated from politics can throw a wild party before the votes are cast. There will be lots of dancing on the tables; by the time voters become sick with an inflation-induced hangover, the election is over. Macroeconomic lore has it that Fed chairman Arthur Burns did such a favor for Richard Nixon in 1972 and that the Bush family is still angry with Alan Greenspan for not adding a little more alcohol to the punch before the 1992 election, when George H. W. Bush was turned out of office following a mild recession.

Political independence is crucial if monetary authorities are to do their jobs responsibly. Evidence shows that countries with independent central banks—those that can operate relatively free of political meddling—have lower average inflation rates over time. America’s Federal Reserve is among those considered to be relatively independent. Members of its board of governors are appointed to fourteen-year terms by the president. That does not give them the same lifetime tenure as Supreme Court justices, but it does make it unlikely that any new president could pack the Federal Reserve with cronies. It is notable—and even a source of criticism—that the most important economic post in a democratic government is appointed, not elected. We designed it that way; we have made a democratic decision to create a relatively undemocratic institution. A central bank’s effectiveness depends on its independence and credibility, almost to the point that a reputation can become self-fulfilling. If firms believe that a central bank will not tolerate inflation, then they will not feel compelled to raise prices. And if firms do not raise prices, then there will not be an inflation problem.

Fed officials are prickly about political meddling. In the spring of 1993, I had dinner with Paul Volcker, former chairman of the Federal Reserve. Mr. Volcker was teaching at Princeton, and he was kind enough to take his