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Can we just say, then, that as there are both inflationary and deflationary fears, policy is on the right lines and we are enjoying rough price stability? Unfortunately we cannot. For great uncertainty about the direction and size of price movements is itself a danger to economic stability.

Not enough attention has been paid to the fact that after their recent plunge, oil and commodity prices are creeping up again. It was the effect of rising prices in these areas in generating inflation that accounts for the slowness of some central banks to shift last year from restrictive to expansionary policies. A renewed upsurge in primary product prices would make life more difficult for central banks’ monetary strategy. But this is not the most important danger. The real worry is that shortages of energy and basic commodities may be imposing real speed limits on world growth well before anything like full employment is regained.

Let us go back to the problem of uncertain overall price movements. There is a long history of indexation proposals for living with inflation. Milton Friedman embarrassed some of his sound money followers by advocating indexed contracts. In the UK the income tax starting points have been indexed to inflation since the 1970s, although the government has the option of suspending indexation when revenue needs are pressing. Social security benefits have long been indexed to inflation, earnings or some hybrid of the two.

There was a long battle during the Thatcher period in the 1980s over whether the government should issue indexed gilts. A long-time governor of the Bank of England, Gordon Richardson, was fiercely opposed as he regarded it as a moral surrender to inflation. But one of his successors, Eddie George, was happy to see the government push them through and was worried mainly that they were not as popular as they should have been. Some 30 per cent of the UK national debt is now in indexed bonds, as is 10 per cent of US debt.

My own view was that refusal to index out of a moralistic disapproval of inflation was akin to refusing to stop knocking one’s head against a brick wall in the hope that the wall would go away. The main snag about indexation lay in the indexation of wages. There are circumstances in which real wages need to rise less quickly than usual or even to fall. This is difficult enough to accomplish when pay talks centre informally on the “cost of living”. It will be far more so if it comes to renegotiating a formally indexed pay agreement.

The indexation discussion has been revived by an American economist, Robert Shiller, with the aid of Lawrence Kay, who has adapted the argument to British conditions. (“The Case for a Basket”, Policy Exchange). One novelty is that the case is now presented as a way of dealing with deflationary as well as inflationary threats. If you buy a widget on an indexed basis you do not have the embarrassment of asking the seller for a reduction because prices in general have fallen. This happens automatically. A second and more important innovation is that he suggests a new unit of account, which he calls the basket, defined to retain its value whatever national inflation indices do. He believes that the failure to supply such a unit is one reason why indexation has not caught on. “It is far easier for most people to say ‘I will lend you 500 baskets at 3 per cent interest’ than to say ‘I will lend you £500 at an interest rate equal to 3 per cent plus the percentage change each month of the CPI’.”

Prof Shiller’s main modern example of such a basket is Chile’s Unidad de Fomento. But the separation of the unit of account from money used as means of exchange goes back a long time. From the time of Charlemagne, trade and contracts in Europe were based on imaginary or ghost monies that were ultimately based on the silver denarius, which no longer circulated or was even seen.

If a unit of account different from the coin of a realm is to be introduced, it would be better to find a more appealing name than “basket”. I cannot imagine anyone being thrilled to be told by his employer that he had been awarded a pay increase of 0.2 baskets.

But the real snag about indexation remains the problem of wages. As Keynes, Prof Shiller himself and many others have observed, workers accept more readily a real wage cut arising from a rise in the general level of prices than an actual reduction in what they are paid. Prof Shiller tries hard to find a unit in which workers could accept with good grace a reduction in real pay; but I do not think he succeeds. In some circumstances a little bit of old-fashioned inflation is the best safety valve available.

Paul Krugman

Currency Crises

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The Big Inflation Scare

Suddenly it seems as if everyone is talking about inflation. Stern opinion pieces warn that hyperinflation is just around the corner. And markets may be heeding these warnings: Interest rates on long-term government bonds are up, with fear of future inflation one possible reason for the interest-rate spike.

But does the big inflation scare make any sense? Basically, no — with one caveat I’ll get to later. And I suspect that the scare is at least partly about politics rather than economics.

First things first. It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.

So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.

The first story is just wrong. The second could be right, but isn’t.

Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all.

Still, don’t such actions have to be inflationary sooner or later? No. The Bank of Japan, faced with economic difficulties not too different from those we face today, purchased debt on a huge scale between 1997 and 2003. What happened to consumer prices? They fell.

All in all, much of the current inflation discussion calls to mind what happened during the early years of the Great Depression when many influential people were warning about inflation even as prices plunged. As the British economist Ralph Hawtrey wrote, “Fantastic fears of inflation were expressed. That was to cry, Fire, Fire in Noah’s Flood.” And he went on, “It is after depression and unemployment have subsided that inflation becomes dangerous.”

Is there a risk that we’ll have inflation after the economy recovers? That’s the claim of those who look at projections that federal debt may rise to more than 100 percent of G.D.P. and say that America will eventually have to inflate away that debt — that is, drive up prices so that the real value of the debt is reduced.

Such things have happened in the past. For example, France ultimately inflated away much of the debt it incurred while fighting World War I.

But more modern examples are lacking. Over the past two decades, Belgium, Canada and, of course, Japan have all gone through episodes when debt exceeded 100 percent of G.D.P. And the United States itself emerged from World War II with debt exceeding 120 percent of G.D.P. In none of these cases did governments resort to inflation to resolve their problems.

So is there any reason to think that inflation is coming? Some economists have argued for moderate inflation as a deliberate policy, as a way to encourage lending and reduce private debt burdens. I’m sympathetic to these arguments and made a similar case for Japan in the 1990s. But the case for inflation never made headway with Japanese policy makers then, and there’s no sign it’s getting traction with U.S. policy makers now.

All of this raises the question: If inflation isn’t a real risk, why all the claims that it is?

Well, as you may have noticed, economists sometimes disagree. And big disagreements are especially likely in weird times like the present, when many of the normal rules no longer apply.

But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.

Needless to say, the president should not let himself be bullied. The economy is still in deep trouble and needs continuing help.

Yes, we have a long-run budget problem, and we need to start laying the groundwork for a long-run solution. But when it comes to inflation, the only thing we have to fear is inflation fear itself.