Rogoff Advises 'Reflation'

Harvard economist Kenneth Rogoff, well known as the co-author of  “This Time is Different”, a book which argues that economic growth can be shown empirically to decline once government debt grows beyond a certain point, used to be an outspoken advocate of the 'price stability policy'. The fact that economists and central bankers defend this policy to this day is actually quite odd, given the experience of the 1920s boom and the subsequent economic depression. The problem is of course that 'price stability' can hide an enormous amount of monetary inflation if it is pursued during a time when economic productivity grows very fast. Nonetheless, it has remained a cornerstone of central bank policy and has consequently produced the giant boom-bust cycles we have been subjected to since the 1990s.

In 1985, Mr. Rogoff authored what is still considered an influential paper, in which he argued that it was more important for the central bank to pursue its price stability mandate than its full employment mandate (obviously this applies mainly to the Fed with its dual mandate). It has to be remembered that at the time, economists still reeled from the 'stagflation' shock. The combination of inflation and recession reared its head in the 1970s and had previously been regarded as an 'impossibility'.

We learn now that Rogoff is abandoning this position in favor of what he terms 'reflation'. This is actually a misnomer, since 'reflation' would presuppose that there is, or was, deflation prior to its implementation. But there hasn't been any deflation, nor is there any. So it would be better to call the spade a spade. What Rogoff wants is even more inflation. According to an article at Bloomberg:


“The economist whose research foreshadowed the unusually long slog back from the 2008 financial crash is calling for the unlikeliest kind of central banker to lead the Federal Reserve: one who welcomes some inflation.

Harvard University Professor Kenneth Rogoff, whose influential 1985 paper endorsed central bankers focused more on securing low inflation than on spurring employment, is highlighting the benefits of a Fed led by either Janet Yellen or Lawrence Summers precisely because they fail his old litmus test. President Barack Obama said Aug. 9 that they are “outstanding” and “highly qualified” candidates to replace Ben S. Bernanke, whose term as chairman runs out in January.

What qualifies them in Rogoff’s view is their dovishness, a refusal to place too much weight on stable inflation at a time when unemployment is far above its longer-run level. Rogoff is espousing aggressive monetary stimulus, even at the cost of moderate price increases. At a time of weak global inflation, higher prices may even help the U.S. economy by lowering real interest rates and reducing debt burdens, he said.

“In more normal times, you’re looking for the central banker to be an anchor against high inflation expectations and to assure investors that inflation will stay low and stable to keep interest rates down,” Rogoff, co-author with Carmen Reinhartof the 2009 book “This Time Is Different: Eight Centuries of Financial Folly,” said in an interview. Now “we’re in this situation where many of the central banks of the world need to convince the public of their tolerance for inflation, not their intolerance.”



(emphasis added)

Good grief. Of course Mr. Rogoff is hardly alone in advocating such policies. As a matter of fact, these absurdities essentially represent the mainstream consensus by now. It is not unusual to see the bankruptcy of a state-run monetary system preceded and accompanied by the intellectual bankruptcy of the government's advisors. In fact, this happens habitually, as can e.g. be seen when studying the history of the Weimar hyperinflation, the assignat inflation in post-revolution France, or other, similar experiences (they need not necessarily have ended with complete conflagrations as happened in these two examples). In every instance, economic theorists argued forcefully that there could be no harm in pursuing a policy of deliberate inflation. Today it is almost comical to read the arguments forwarded by people like Helfferich and many others who insisted as late as the summer of 1923, in the middle of an utter collapse of the currency, that the policy of the Reichsbank was not to blame for the situation.

As for central banks needing to 'convince people of their tolerance for inflation', anyone who takes the time to follow the growth in the money supply is presumably already convinced. However, as is always the case in the early stages of a major monetary inflation episode, a critical mass of people continues to believe that the policy will be abandoned or reversed 'in time'. It is their demand for money which is the decisive factor that keeps the effect on prices in check, or let us rather say, keeps it focused on financial instruments. We interpret Mr. Rogoff's remarks to indicate that he wants the central bank to upset the 'inflation expectations' of this group, so that its demand for money declines. This would surely be playing with fire, given the sheer size of the money supply expansion that has occurred over the past five years.




US money supply TMS since January 2000. Note the acceleration in monetary inflation since 2008 (chart via Michael Pollaro) – click to enlarge.



Before we discuss why such proposals make no sense, let us briefly look at a few other commentaries along a similar vein we have come across just over the past several days.


'Fixing' the Euro Area's Imbalances

Inflationism is not only popular as a supposed solution to the sluggish recovery in the US labor market. The euro area's problems are also held to be amenable to it, as a recent article published at Marketwatch indicates. After pointing out that the euro area's problems are far from overcome, the author points to a study by two US economists:


“In a new paper called “Cross of Euros,” two economists compare the challenge facing the euro zone to the “cross of gold” confronted by the U.S. in the 19th century as this country worked to create a successful currency union.

The EU is arguably just at the beginning of this long process, but the problem, say Kevin O’Rourke of Oxford University and Alan Taylor of University of California-Davis, is that time is already running out.

“The nature of modern economies, and of politics in the independent democracies that comprise the euro zone, is such that Europe may not have the luxury of experimenting for 140 years before finding workable arrangements,” they write in a recent article for the Journal of Economic Perspectives.

The two economists examine the historical lessons from the monetary straitjacket of the gold standard to prescribe a solution for the similar situation in the euro zone that must, they say, include higher inflation to smooth the necessary economic adjustment.

“The history of the gold standard tells us that an asymmetric adjustment process involving internal devaluation in debtor countries, with no corresponding inflation in the core, is unlikely to be economically or politically sustainable,” O’Rourke and Taylor say.

In their view, Europe needs a more flexible policy mix, including looser monetary policy, a higher inflation rate, a weaker euro, debt restructuring, and fiscal stimulus by core governments to balance out the adjustment process and reduce the risk of a euro collapse.


(emphasis added)

We find it highly amusing that there are economists who argue that what is required to avoid the 'collapse' of a currency is more inflation. It is even more amusing that while they make these demands, 'more inflation' and 'stimulus spending by the core' is exactly what has been implemented already for the past several years, in spite of all the rhetoric to the contrary.

We want to remind readers in this context of a chart we have previously shown that depicts tax revenues and government spending in the EU. Obviously the bulk of the spending increases is concentrated in the so-called 'core'. Whether one calls it 'stimulus spending' or something else is pretty much irrelevant. With regard to inflation, the true money supply in the euro area has lately grown at an 8% year-on-year pace. The only thing we can agree with is that debt restructuring (in lieu of bailouts) is indeed necessary.


Japan Should 'Set Fire to its Debt'

Next let us move on to Japan. We have the certified monetary crank Ambrose Evans-Pritchard arguing in favor of '100% debt monetization by the BoJ' and proposing that it should then simply 'set fire to the debt' to get rid of it. Evans-Pritchard is apparently forgetting that there is a liability on the other side of the BoJ's balance sheet that goes by the name of 'yen'. Admittedly, since it is an irredeemable fiat currency anyway, one could argue that it does ultimately not matter what inhabits the asset side of the central bank's balance sheet. However, the fiat money system more than any other relies on confidence and requires that at least everybody be prepared to pretend that there is something 'backing' the money issued by the central bank. The last time a major central bank monetized 100% of the debt issued by the government was in Germany in 1923. We all know how that turned out.

In addition, a vast part of the population's savings have in fact been invested in JGBs, either directly or indirectly. To say that a collapse of the currency and the JGB market would have grave consequences would be an understatement. It is not unimportant whether the policy implemented to deal with previously incurred debt favors debtors and the imprudent to the detriment of creditors and the prudent. It seems to us Evans-Pritchard doesn't much care that he might just as well toss Japan's widows, orphans and retirees on the pyre he wants to see erected.

Moreover, he simply makes up some history along the way. The Roman empire didn't collapse when it started to resort to monetary inflation according to Evans-Pritchard. This will be news to most historians, because that is what definitely did happen.

He also pronounces Japan's Takahashi Korekiyo a hero for “doing the same thing in the 1930s”, but as a matter of fact, Takahashi actually did not do the 'same thing'. The underwriting of bonds was counterbalanced by sales of securities (at a ratio of 10:9), draining excess funds from the markets and tightly controlling the growth of the BoJ's balance sheet. As soon as the economy recovered, Takahashi tried to scale back the underwriting of bonds, which led to a clash with the military. Only after he was assassinated in 1936, did BoJ bond buying soar, and the central bank's balance sheet expanded enormously as it provided inflationary financing for the war. So how did that experiment in unbridled inflationism turn out? Not only did it make a brutal war of conquest and occupation possible, it ultimately ended in hyperinflation and the complete collapse of the currency twelve years after the policy was started. None of this is mentioned by Evans-Pritchard.

Evans-Pritchard's interpretation of Roman history is similarly creative. Even though there were certainly both ups and downs following the first major deployment of the debasement policy, no historian doubts today that it spelled the beginning of the end for the Roman empire. The 'ups' incidentally invariably coincided with attempts to reintroduce sound money. It should be obvious if one thinks about it a little bit: why would a strong, healthy empire have felt the need to resort to inflation?

The third century AD is known as the 'century of crisis'; at its beginning, emperor Caracalla accelerated the previously slow debasement policy of his immediate predecessors Marcus Aurelius and Septimius Severus. A century of total chaos ensued. No fewer than 26 emperors acceded to the throne in the third century, and only a single one of them died a natural death. Between 258 and 275 AD, a time of civil war and numerous invasions, silver coinage was for all intents and purposes completely abandoned (the silver content of the denarius fell to 0.5%). Prices rose by 1,000%. When Diocletian acceded in 284, he initially attempted to restore some of money's value by issuing better quality coinage,  but the effort didn't last long. In the end, his reign was marked by galloping inflation as well (his edict on coins in 301 devalued the most widely circulating coin by 50%), which led to attempts to introduction of price controls (via the edict on maximum prices) that were coupled with draconian punishments (i.e., the death penalty). 

In a preview of how many governments would later attempt to shift the blame for inflation on others, Diocletian blamed 'greedy merchants' for rising prices. The price controls were an early example of economic lunacy and led to widespread shortages, riots and many deaths. They had to be abandoned within one year. Diocletian had fixed the denarius at 50,000 to a pound of gold in 301; by the time his successor Constantine died in 337, the denarius was at 20,000,000 to a pound of gold. The 3rd ad 4th century were thus marked by inflation, constant wars, an enormous expansion of the military and the bureaucracy, continually rising and ever more onerous taxation and a sharp decline in the freedom of Rome's citizens. Evans-Pritchard seems to think none of this was a particularly bad idea and we should therefore not shrink from emulating the monetary quackery that was at the root of these developments. Nothing bad can possibly happen.




Roman emperor Caracalla, inflationist, war monger and “remembered as one of the most notorious and unpleasant of emperors” for the persecutions and massacres he authorized.  He reigned together with his father Septimius Severus from 198 to 211, then with his brother Geta in 211 (until he murdered him), and then alone from 211 to 217.

(Photo via Wikimedia Commons)




One question that needs to be asked is of course: if it is true, as Mr. Rogoff and so many others state, that by 'tolerating a little bit of inflation' we can ensure an improvement in the labor market, why shouldn't it be done?

We may admit that at first, inflation almost always appears to be beneficial. After all, its object is to suppress interest rates below the natural rate, and so it will lead to the initiation of all sorts of investments and economic activities that would not have been initiated otherwise. However, all economic activity is ultimately funded by the economy's pool of real savings. This pool cannot be increased by printing additional money. Introducing new money can merely lead to a redistribution of wealth to those who get hold of the new money first from those who receive it later or not at all. Since the investments undertaken can actually not be fully funded (the real savings to do so don't exist) and are not in accordance with the wishes of consumers (which are expressed by their time preferences which the suppression of interest rates masks), the economy is undermined structurally even while there seems to be a 'recovery' in train. Inflation alters relative prices and thereby upsets economic calculation; accounting profits later turn out to have been capital consumption in disguise.   There is invariably a price to pay for the short term sugar high provided by inflation. We simply cannot get something for nothing, which is what the supporters of inflationary policy appear to believe.

Those who argue that it makes no sense to worry about the long run given the 'short term emergency' are forgetting that the long run is already here. After all, similar arguments were forwarded when Alan Greenspan's Fed pumped up the money supply and cut interest rates to the bone after the Nasdaq bubble's demise. This was followed by a few years during which the Fed and its apologists were doing victory laps for seemingly having successfully addressed the aftermath of the burst bubble. Too bad that it ultimately brought us the 'worst crisis since the Great Depression'. Look at what has happened since then: the most sluggish recovery of the entire post WW2 period. Why is the recovery so weak? There are two main reasons: the economy suffered enormous structural damage in the preceding boom and the recovery has been accompanied by bailouts, massive deficit spending and monetary pumping, all of which have delayed the necessary adjustments.

How can anyone possibly believe that even more of the same of what the Greenspan Fed did, only on an even grander scale, will have a different outcome? It is of course a good bet that the next crisis will indeed look different from the last, so it is going to be different in that sense at least – but that is not the outcome the supporters of inflationism are expecting or promising. We assume that Mr. Rogoff is e.g. convinced that if the effects of inflation should become highly visible and threaten to 'get out of hand', the central bank could easily counter such a development by implementing tighter policy. This is actually not wrong, it can in theory do so – but not without accepting a 'stabilization crisis', i.e. the very thing its current policies are designed to avert. It should be obvious that the earlier the crisis is allowed to play out, the less painful it will be. The one thing that we cannot possibly expect to get is an 'eternal boom'.



rogoff02Kenneth Rogoff: abandoning 'price stability' for 'reflation'.

(Photo via





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3 Responses to “Parade of the Inflationists – or A World Gone Mad”

  • SavvyGuy:

    These clowns are pathological control freaks. They have ZIRPed themselves into the zero-bound corner, and therefore are not able to pull on the interest-rate leash any more. So now they want to reflate like mad, just to get some tension going on that leash, and then they’ll be in control again!

    • JasonEmery:

      savvy said, “…then they’ll be in control again!”

      I think they have permanently forfeited control.

      Are you familiar with the work of John Hussman? Basically, he says that the fed cannot raise short term rates even 25 basis points without first REDUCING base money by about a half trillion. Got that? No tapering. Bring the bond purchase programs (QE-X) to HALT, and sell a half trillion of what you already bought, and that is good for only a 25 basis point increase!!!

      He plots the liquidity preference curve. The ‘y’ axis is the rate on 3-month treasury bills, and the ‘x’ axis is the monetary base per dollar of nominal gdp. Right now, 3-month treasury bill yields are near zero, and base money ($3.5 trillion) divided by nominal gdp (not sure, but over $15 trillion) divides out to over 20%!!! But if you look on the ‘liquidity preference curve’ (see link), they would have to cut base money to less than 10% of nominal gdp to raise short term rates to 2%.

      • mc:

        Hussman has been way ahead of the economic press on this one. Holding rates low requires consistent growth of the Fed’s balance sheet, and even a hint of a slow down in the buying, much less a gigantic reversal of at least a year or two of QE, causes rates to soar and equities to tank.

        No chance of a low-pain exit, increasing chance of a complete meltdown.

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