Nobel laureate and noted economist Paul Krugman believes controlling inflation by inducing a recession is like stopping the action on the field until everyone sits down again. It works, but at a cost, Krugman tweeted.
What Happened: Krugman, in a series of tweets, was replying to French economist Olivier Blanchard who is also a Senior Fellow at the Peterson Institute for International Economics. Blanchard had tweeted that a point often lost in discussions of inflation and central bank policy is that inflation is fundamentally the outcome of the distributional conflict, between firms, workersand taxpayers.
It stops only when the various players are forced to accept the outcome, he explained.
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Blanchard elaborated saying the source of the conflict may be too hot an economy "In the labor market, workers may be in a stronger position to bargain for higher wages given prices. But, in the goods market, firms may also be in a stronger position to increase prices given wages. And, on, it goes, wrote Blanchard.
Replying to Blanchards take on inflation, Krugman responded, saying, One way to think about inflation is that it's like a sports event where everyone stands up to get a better view of the action which is collectively self-defeating.
Krugman provided an analogy saying controlling inflation by inducing a recession is like "stopping the action on the field until everyone sits down again" and that although it works, it has a cost. Much better if we could get collective agreement by everyone to sit down without stopping the game. That's hard to achieve, but not always impossible, Krugman tweeted.
Israels Strategy: Krugman cited the sharp disinflation strategy adopted by the Israeli government in 1985 to reduce inflation from a whopping 500% per annum. The more or less painless 1985 Bruno disinflation in Israel was pretty much exactly that: all the major parties agreed to stop trying to leapfrog each other, and inflation came down right away, Krugman pointed out.
The noted economist said that the 1968 Phelps paper, which simultaneously and independently introduced the natural rate hypothesis, worked pretty much that way Staggered wage-setting, and in a hot labor market everyone trying to get ahead of everyone else with inflation possibly getting entrenched if everyone expected it to persist.
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