There is a kind of logic to it, especially when combined with the often-difficult identification of cause and effect when economics and human behavior are involved. That has been enough to sustain the appeal of the idea into modern times, where it shows up mostly in the "build it and they will come" theory of economic, and professional sports, development.
They are not building straw airplanes anywhere in Washington, D.C. as far as we know, but there is more than a trace of cargo cult thinking in the latest idea being floated around economic policy circles: purpose-driven inflation.
According to the latest policy theory, what our economy needs to awaken it from its stupor is to be doused with a bucketful of inflation. Previous periods of rapid growth in output and employment have been accompanied by inflation, so if we build some inflation and economic growth will be sure to land -- uh oh, strike that -- economic growth will naturally follow.
The theory has been around for several decades now but seems to be gaining momentum, spurred not only by the failure of existing monetary policies to move the economic growth needle but also by the nomination of Janet Yellen to succeed Ben Bernanke as head of the Federal Reserve. While Fed chairmen have been known to change once they take the helm, Yellen has been friendlier to this idea than Bernanke.
There is a good deal of economic research backing up this theory, and two staff economists at the New York Federal Reserve, Gauti Eggerstsson and Marc Giannoni, have done an excellent job compiling and analyzing the best of the past work and current argument. A copy of their latest report is available at www.newyorkfed.org/research/staff_reports/sr608.pdf.
The authors of the report have also tried to square the theory with our economic experience of the 1970s, which was an economic "Toad's Wild Ride" that few would wish to repeat. During the 1970s we managed to screw up our economy almost beyond recovery, and we did it our way, with monetary policy that combined a prolonged easy money policy and bonehead decisions.
One result was during one 18-month period the stock market lost 40-percent of its value, a disaster not replicated until the financial collapse of 2007-2009.
The prime rate, the interest rate that banks charged their very best corporate borrowers, went from 4.5 percent in 1972 to 21.5 percent in 1980. Unemployment reached double digits, a level not seen since the 1930s Depression. Economic growth stagnated while inflation soared, a theoretically impossible situation so very much with us that we had to create a word for it: "stagflation."
Today's monetary policy makers are very aware of the mistakes of the 1970s, and if they weren't, there are members of Congress who would remind them. Still, there are those who believe that, based on our new knowledge of human behavior they can inject just the right of amount of inflation into our economy and keep it under control.
To some veterans of the 1970s financial markets, the kind of economic policy being considered sounds a lot like a scheme to use a dragon's breath as a source of warmth in a cold winter. Dragons are notoriously difficult to control, and impervious to even the latest theories. So is inflation.
When discussing the merits of the purpose-driven inflation policy, we should include its massive income transfer and asset value effects. The principal beneficiaries of inflation are debtors, none more so than our own federal government, the world's largest debtor. That benefit is offset by the cost to those who hold debt-based financial assets like bonds, mortgage, and pension annuities. The largest net effect is a massive income transfer from individuals on fixed incomes to the federal government.
The federal government also has a second, smaller financial interest in inflation because the force of inflation will eventually cause incomes to go up, and our progressive tax rates mean that the feds will take an increased share of peoples' incomes.
If inflation were to return with a roar, the Federal Reserve, which holds over $3 trillion worth of Treasury bonds, would take a bath of epic proportions. Its losses could quickly drive the central bank into insolvency, a potential outcome that should encourage even the most confident dragon tamers to re-think the whole idea of purpose-driven inflation. Let's hope so.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.
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