Re: Does Debt Matter

[larson@xxxxxxxxxxx (S R Larsson)]

>>Per:
>>The debt is too high if there is too much inflation. I would argue that
>>double-digit inflation is too high. My own preference would be an inflation
>>rate (in the GDP deflator or some similar index) in the range of 2--8
>>percent per annum. Above 8 percent is "too high", I think.
>
>William:
>I think a small positive inflation rate is desirable since it
>acts as a lubricant to the economy.  However a fluctuating
>inflation rate in the range of 2 to 8 percent would be very
>troublesome in investment planning, and would negatively impact
>business efficiency.  Does the historical record show that good
>long term real growth can coexist with a persistent inflation
>rate in the high end of your range?
>

Per's argument is not that inflation should be fluctuating, but that a
stable growth in prices within that range of 2-8% means no danger to the
economy. Fluctuating prices always create uncertainty in business planning.
On a recent trip to the US I spoke on the plane with a man who works for a
small Swedish manufacturer in hydraulics. He told me, speaking of price
stability, that in the '80s when the Swedish economy suffered not only from
tax-driven inflation, but from fluctuating inflation (swings were from 10%+
in 1980 to 4%- in '86 back up to 10%+ in 1989-90) his firm budgeted
constantly for 6-8% inflation just to make sure they escaped the
uncertainty of price flexibility as far as possible.

It is a common misinterpretation of inflation theory that inflation means
fluctuating prices. All it means is that there's a pace in price growth.
Normally, the problem with inflation is smaller than the problem with
swings in inflation rate - especially if there are moments of deflation
involved. Once inflation reaches very high levels (10% or more is a good
reference mark) the mere level will make corporate planners more
short-sighted and concerned with preserving stock values, near-future cash
flows etc than with planning for future activities.

It deserves to be pointed out also that deflation has its own diabolic
effects. Sweden (our beloved example of galactic misery cause by galactic
ignorance) has been on a deflation tour for a year now. As a consequence,
no corporations invest for domestic production, since the value of the
products let out tomorrow will be too low to pay for the investment as
financed today. Households will be very reluctant to assume debt if they -
as a consequence of deflation - can look forward to lowered money wages.
Since deflation is accelerated when economic activity is brought to a
standstill, it is a cruel vicious circle that sends economies off on a
devastating downspin. Deflation, in short, kills growth at least as
effectively as does double-digit inflation.

-----
Sven Robert Larsson
Address:        Roskilde University
                      Department of Social Sciences, Bldg 22.1
                      Pb 260
                      DK-4000 Roskilde, Denmark
Telephone:      -45 4674 2910