Greenspan, welfare states & inflation

Alan Greenspan, perhaps the world's most over-rated person, is warning of higher inflation. Why?
Here's what he says (pdf):

In the type of welfare economies that we all have, which required the abandonment of the gold standard, there has been a certain amount of inflation, which people have largely been willing to accept for the benefits of the economic safety nets which have been constructed.
But the problem is that the number is not 2%. Historically it's obviously been more than that.

This echoes back to Greenspan's work for Ayn Rand, where he argued that welfare states required the abandonment of the gold standard and hence printing money and inflation.
There are two problems with this.
First, it's not welfare states as such that create inflation, but rather people's short-termism.
The argument that welfare states are inflationary is simple. The public want welfare spending, but not taxes. So governments have incentives to borrow money . And it's easier to finance that borrowing by printing money than by issuing bonds. So governments abandon the gold standard in favour of fiat money.
But the root cause here is not the welfare state, but rather the public's gullibility. If the public responded to a government that printed money by thinking: "this is going to lead to inflation, and inflation is bad for us" governments would have no incentive to leave the gold standard - especially as it's remarkably easy these days for them to borrow in bond markets.
The welfare state here is a sideshow. Imagine a democratic government in a minimal state facing election. It decides to bribe the voters by a one-off hand-out, financing the bribe by printing money, causing inflation later. There's no welfare state here in the sense we understand it, but inflation arises because the public are daft enough to elect a government that creates it.
The second problem is that political authorities don't just support ordinary people.
Right now, markets are worried by the possibility of inflation, despite today's numbers. Yields on index-linked gilts are low and break-even inflation rates are high; gold has risen above $700/oz; and the Baltic dry index (a neat short-term lead indicator of US producer prices) is near a record high.
But the market ain't worried because it fears more generous welfare for workers.  Markets fear that central banks (led by the Fed today) will cut interest rates even though the global economy is still so strong as to generate inflationary threats - in an effort to bail out bank bosses and fund managers who gambled, lost and are now whining like snotty-nosed five-year olds.
So, insofar as the welfare state generates inflation, it's welfare for capitalists that's the problem, not welfare for workers. Oddly, Mr Greenspan hasn't mentioned this.

Comments

[dearieme]

I clicked on your link to Index-Linked Gilts, only to read "We are currently experiencing problems with our database and are working urgently to resolve these. (Details)
If you are looking for PWLB daily rates please call 0845 357 6610". Cheering, eh?

Anyway, once we've hanged all the socialists and all the lawyers, let's hang those reckless banker chappies too.
Pour decourager.

[kinglear]

Greenspan overrated? Shurely not. He must be the most ignorant economist ever - and I speak as an ignorant economist. When he was being confirmed as Chairman of the Fed, one of the Senators raised his record in business - which had been crashingly bad. "I guess it's about time you started getting things right, according to the law of averages", he sighed. Despite the titters, unfortunatley, he has never ever manged to get it right

[pommygranate]

Chris

Two things.
a) the link at About.com of a description on Ayn Rand and her philosophy is not even worthy of a 2007 GCSE student. i'm sure you can find a better link than this.

b) but the public are short term and they are gullible. that is why welfare economies are inflationary. Greenspan is right.

[Sergent Howie]

Well, people may not be so guilible. One can say that an increase in welfare has a near 100% chance of happening while the inflation increase may not happen due to various factors (innovation, international context...).

So they choose to get what is certain (welfaire gains) and afford the risk of probable but not so certain inflation. This may not be the wisest choice, but it has a rational explanation.

[pommygranate]

Sergent

Innovation in welfare provision? The only way inflation could be avoided in providing welfare is thru productivity gains of the Dept Social Security.

mmmm...

[Alex]

Ayn Rand and her philosophy is not even worthy of a 2007 GCSE student

Fixed it for you - should be "Ayn Rand and her philosophy *are* not even worthy of a 2007 GCSE student":-)

The broader point here is of course the assumption that a gold standard would be a good thing anyway, to say nothing of the ahistorical claim that the gold standard broke down because of welfare states (hint: WW1).

[Mark Wadsworth]

I agree he is over-rated.

But the UK government is going to need high inflation for a few years to mask the fall in real house prices - at least the nominal fall in house prices will be much lower (see early 1990s).

[pommygranate]

Alex

err, no. It is in fact 'is' not 'are'. re-read my sentence, you tedious pedant, you.

[Sean of Sheffield]

Rand and Marx where pretty much much of a much ness, both absolutist philosophies in the Aristotle mold.

Wasn't Greenspan rands toy boy at one time?

[Mark Wadsworth]

That was a nice trap that Pommy set for Alex, I must try that out sometime.

[Blissex]

«If the public responded to a government that printed money by thinking: "this is going to lead to inflation, and inflation is bad for us"»

But this argument is based on a common and ridiculous use of «us». As Mrs. Thatcher famously pointed out there is no such thing as society -- there are discrete and competing interest groups.

Inflation can be pretty good for some and irrelevant for many. Voting to get yourself state subsidies now to be paid later by someone else with inflation can be a very good deal for enough people.

As Milton Friedman should have said, inflation is always and only a political phenomenon, and who gains and loses is a distributional issue, not something that affects «us» equally.

«So, insofar as the welfare state generates inflation, it's welfare for capitalists that's the problem, not welfare for workers.»

Exactly, it is a distributional issue. For example currently in the USA a lot of increased spending, including war spending, is being funded not with extra taxes, but with lower taxes on the rich, and borrowing, that will have to be repaid by ''everybody''.

The distributional impact matters, and «us» is sad escapism.

[Kevin Carson]

Sean,

Like the man said, Greenspan "work[ed] for Rand." Better him than me.

Seriously, though, it's amazing how many on the right can argue with a straight face that the massive political power of single welfare moms is the main source of government intervention in the economy. They're the sort who'd say the primary political force behind Food Stamps was black welfare queens, rather than corporate welfare queens like ADM and Cargill who contributed to Bob Dole's campaign.