Page 634 - The Principle of Economics

650 PART TEN MONEY AND PRICES IN THE LONG RUN
IN THE NEWS
How to Protect Your Savings from Inflation
AS WE HAVE SEEN, UNEXPECTED CHANGES in the price level redistribute wealth among debtors and creditors. This would no longer be true if debt con- tracts were written in real, rather than nominal, terms. In 1997 the U.S. Trea- sury started issuing bonds with a return indexed to the price level. In the following article, written a few months before the policy was imple- mented, two prominent economists discuss the merits of this policy.
Inflation Fighters for the Long Term
BY JOHN Y. CAMPBELL
AND ROBERT J. SHILLER Treasury Secretary Robert Rubin an- nounced on Thursday that the govern- ment plans to issue inflation-indexed bonds—that is, bonds whose interest and principal payments are adjusted upward for inflation, guaranteeing their
real purchasing power in the future. This is a historic moment. Econo- mists have been advocating such bonds for many long and frustrating years. Index bonds were first called for in 1822 by the economist Joseph Lowe. In the 1870s, they were cham- pioned by the British economist Wil- liam Stanley Jevons. In the early part of this century, the legendary Irving Fisher made a career of advocating
them.
In recent decades, economists of
every political stripe—from Milton Friedman to James Tobin, Alan Blinder to Alan Greenspan—have supported them. Yet, because there was little public clamor for such an investment,
the government never issued indexed bonds.
Let’s hope this lack of interest does not continue now that they will become available. The success of the indexed bonds depends on whether the public understands them—and buys them. Until now, inflation has made government bonds a risky investment. In 1966, when the inflation rate was only 3 percent, if someone had bought a 30-year government bond yielding 5 percent, he would have expected that by now his investment would be worth 180 percent of its original value. However, after years of higher-than- expected inflation, the investment is worth only 85 percent of its original value.
Because inflation has been mod- est in recent years, many people today are not worried about how it will affect their savings. This complacency is dan- gerous: Even a low rate of inflation can seriously erode savings over long peri- ods of time.
Imagine that you retire today with a pension invested in Treasury bonds that pay a fixed $10,000 each year,
the short run. Later in this book we will examine the reasons for short-run mone- tary nonneutrality in order to enhance our understanding of the causes and costs of inflation.
Summary
N The overall level of prices in an economy adjusts to bring money supply and money demand into balance. When the central bank increases the supply of money, it causes the price level to rise. Persistent growth in the quantity of money supplied leads to continuing inflation.
N The principle of monetary neutrality asserts that changes in the quantity of money influence nominal variables but not real variables. Most economists believe that monetary neutrality approximately describes the behavior of the economy in the long run.