QE3? Should the West actively encourage inflation?

9th August 2011

Along with fellow academic Carmel Reinhart, they have argued that history shows that too much borrowing in terms of GDP is a drag on economic growth.

However Rogoff also believes that western Governments are stuck in a liquidity trap and may need to purposely target inflation of 4 to 6 per cent to ease paying down public and private debt. Without inflation, the pain, he says, will be a lot worse.

Indeed he suggests that we start calling the current economic crisis the Great Contraction – not a recession because that has led to the wrong policy response.

Rogoff has been doing the media rounds putting forward this point of view including on the BBC's Newsnight – although he has been making the case for this for several years.  Here is his latest view in a column for the China Daily from a few days ago.

Among other things, this would mean the US undertaking another round of Quantitative Easing or QE3 but this time, it would accept that the move is designed to create inflation.

Rogoff accepts that this is risky. Inflation can, in the technical parlance embed, overshoot and bring a host of new problems.

The British public might well argue that Britain's version of Quantative Easing has already succeeded in stoking inflation though monthly inflation has fallen back a little.

Rogoff's interpretation of the economy is that we are closer to the Great Depression.

At the time, President Roosevelt did actively stoke inflation as part of plans to revive the US economy though people are still arguing about which bits of his New Deal worked and which didn't.

But even if politicians and bankers don't abandon their inflation targets just yet – or at least not officially – is the way open for QE3? It now has some supporters.

Here is Clive Crook writing for the Atlantic who styles himself an inflation hawk. But not now.

"Far from worrying about rising inflation, the Fed and the ECB need to see that the situation is deteriorating to the point where engineering a spell of higher inflation is actually the right goal. I understand the dangers. In ordinary times, I am an inflation hawk. But these are not ordinary times. Ken Rogoff puts the case well."

On Seeking Alpha veteran financial journalist James Picarno seems to agree and says the big problem now is avoiding deflation.

He writes: "More quantitative easing. Granted, this is no silver bullet. But as a last effort at keeping deflation from returning, it's the only game in town.

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