Down with stability.

• Author: Grant, James
• Position: Economic stability - Essay

It's a contentious speaker who sets out begging to disagree with the theme of the program on which he is honored to appear. But really, "Restoring Global Financial Stability"? Stability, so-called, was the false god of the bubble years. Instability is the way of the world. Honest turmoil is my topic for today. I'm all for it.

Apparent Stability

You will remember the Great Moderation. In the blissful 20 years only recently ended, you thought you could see forever. Under the stewardship of the likes of Alan Greenspan and Jack Welch, inflation was low, recessions were mild, and corporate earnings growth was predictable. General Electric, the great American blue chip, met or exceeded per-share profit estimates every quarter for 10 consecutive years. It was an astonishing display of stability. Indeed, as the SEC subsequently found, it was literally unbelievable. Management had cooked the books. Neither confirming nor denying the truth of that shocking allegation, GE spent $50 million of the stockholders' money to make it go away.

As GE delivered apparent stability in earnings growth, so the Fed produced apparent stability in the value of the dollar. In 1980, the Fed's preferred inflation gauge was rising in excess of 10 percent a year. By the mid-1980s, it was rising by less than 5 percent a year, and for the past 15 years by less than 3 percent. No federal investigatory agency has looked into this feat of macroeconomic management, but I have my suspicions. The fall of communism and the rise of digital technology pushed down production costs. The global supply curve shifted downward and to the right. Absent a corresponding shift in the global demand curve, one would have expected prices to fall. But, in dollar terms, as the author Judy Shelton (2009) recently noted in the Wall Street Journal, prices mysteriously crept higher. By rights, they should have crept lower.

"Price stability" is a fine phrase, though you won't find it defined in the law. Functionally, the Bernanke Fed defines stable prices as just a little inflation--say, on the order of 2 percent a year. Some years ago, Alan Greenspan had another idea. "Price stability," he proposed, "is best thought of as an environment in which inflation is so low and stable over time that it does not materially enter into the decisions of households and firms." The Maestro so opined in 2001, just as house prices were beginning to levitate. This was not inflation by the lights of the Fed's preferred price index, the personal consumption expenditure deflator. But it was inflation as Greenspan seemed to define the word. I must say his definition appeals to me. Soaring house prices certainly "entered into the decisions of households and firms." For a time, nothing else seemed to enter into our collective financial decisionmaking. We had home on the brain. Yet, there was no inflation problem. Even Greenspan himself said so.

Borrowing from the canon of Austrian economics, I would define inflation not as rising prices but as too much money. Rising prices are a symptom of the excess--and those prices may materialize at the checkout counter, on the stock exchange, or in the realtor's office. Similarly, I would define deflation not as falling prices but as too much debt. Falling prices are a symptom of that excess. One might say that inflation is a monetary phenomenon, deflation a credit phenomenon. One might so say--but, in Washington, D.C., one usually doesn't say. Here, inflation is the...