08/12/2008 05:12 am ET | Updated May 25, 2011

The Monomania of Economists

I have delayed writing this brief piece for some time. But there is something sad if not tragic in watching so many economists rail on today about the dangers of inflation in the current environment. The double digit inflation of the 1970s was a watershed event that changed the predominant economic thinking -- in my view, mostly towards the simplistic and unicausal.

Even slight upticks in inflation were to be wiped away for fear they would raise worker, consumer and business expectations of still more inflation -- and thus make higher inflation inevitable.

Economists, like most other species, usually fight the last war. Now many economists see the rapid rise in oil and food prices as the true looming threat to economic expansion in the future.

But the current environment is so different as to make comparisons with the 1970s absurd. One, there is no comparable union power today, which index automatic wage hikes to inflation. Two, there is a different philosophy at the Federal Reserve than in the 1970s. The Fed may get somewhat more lenient but it is far less tolerant of inflation than it once was, and consumers, business and workers basically know this. This knowledge that the Fed will slam in the brakes if necessary dampens inflationary expectations. Three, there is today a deep and dangerous credit crunch due to the sub-prime crisis and housing bubble, which is driving the rich world's economies into serious recession and whose bottom is not in sight. This in itself is highly anti-inflationary and, in case anyone has not noticed, did not exist in the 1970s.

Should we combat inflation by raising rates now that credit is already drying up rapidly? No. The weight of risk is much heavier on the side of steep recession, high unemployment, slow recovery, and widespread middle class pain.

But the economic monomania about inflation is not entirely simplistic. Inflation existed before unions had power. In fact, the theory, derived from Milton Friedman, does not depend on union power at all. It argues that driving the economy too hard (pushing the unemployment rate down too far) can generate inflationary expectations at any and every point in history.

That reach for universality is the theory's central weakness. The propensity to inflation of an economy depends on the many circumstances of the time. But the deeper failing of the theory is the presumption that if inflation is controlled, all else in the economy will work well -- the extreme neo-classical assumption about the self-adjusting properties of free market economies.

I doubt many observers realize that these economists basically favor an inflation rate of zero. They tolerate one or two percent because they think the official numbers overstate the actually inflation rate.

I also doubt that people realize how little empirical evidence there is to support their case. There is no evidence that a little more inflation will lead to a significant upturn in inflationary expectations. There is only evidence that a lot of inflation will.

The anti-inflationary policy makers are preaching a simple ideology. (They do look in surveys for even minor signs of rising expectations, and then raise alarms.) To be more kind, they want to make the mistake of being too tight, not too loose.

There is no mistake now, however, that the risks of economic devastation from worldwide credit crises is far greater than tolerance of another percentage point of inflation. The dangers are clear and overwhelming and even the ideologues should be able to see that.

Economic policymaking is a pragmatic art, based in knowledge and theory, but chastened by their limitations.

Society must deal with natural restraints on oil and food production, but that is a long-term battle. It must first win the current battle of easing the housing market to a softer landing and avoiding a further and more dangerous meltdown of credit. Ideology is always on the side of one-dimensional and rapid solutions. Remember shock therapy in Russia? Pragmatism is on the side of slow and steady and boring. Call it gradualism.