Re: Does Debt Matter

[wfhummel@xxxxxxxxxxxxxx (William F. Hummel)]

On Wed, 29 Oct 1997 Sven Larson wrote:

>>>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.
-------------
The annual inflation rate in the U.S. for the 12 years from 1970
through 1981 averaged 8.0%.  On an annual basis, the standard
deviation for those years was 3.8%.  The range was 3.4% to 13.3%.

These figures, I think, clearly demonstrate that relatively high
inflation rates can (and usually do) involve considerable
volatility.  The assumption that the inflation rate can be well
controlled at some relatively large value like 8% is very
suspect.

>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.
-----------
I think it is generally recognized that deflation is a serious
problem, and perhaps more to be feared than inflation.  One of
the longest periods of steady growth in the U.S. economy has been
during the last few years of mild inflation, averaging around
2.7% on the CPI.   Another extended period of steady growth was
1955 through 1966.  The average annual inflation rate then was
1.75%.  The standard deviation was 0.88%.   Based on this
evidence, it is my conviction that the economy does best under
the condition of a low positive inflation rate with little
volatility.  I think it is up to those who propose moderately
high inflation rates to demonstrate that both reasonable
stability in the rate and satisfactory economic results are
possible under those conditions.

William F. Hummel