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Saturday, August 25, 2012

Unfounded Fear of Inflation

As a follow up to this post on Inflation Lessons from Paul Krugman:

Demand-siders like me saw this as very much a slump caused by inadequate spending: thanks largely to the overhang of debt from the bubble years, aggregate demand fell, pushing us into a classic liquidity trap.

But many people — some of them credentialed economists — insisted that it was actually some kind of supply shock instead. Either they had an Austrian story in which the economy’s productive capacity was undermined by bad investments in the boom, or they claimed that Obama’s high taxes and regulation had undermined the incentive to work (of course, Obama didn’t actually impose high taxes or onerous regulations, but leave that aside for now).

How could you tell which story was right? One answer was to look at the behavior of ... inflation. For if you believed a demand-side story, you would also believe that even a large monetary expansion would have little inflationary effect; if you believed a supply-side story, you would expect lots of inflation from too much money chasing a reduced supply of goods. And indeed, people on the right have been forecasting runaway inflation for years now.

Yet the predicted inflation keeps not coming. ... So what we’ve had is as good a test of rival views as one ever gets in macroeconomics — which makes it remarkable that the GOP is now firmly committed to the view that failed.

Note what's been happening to estimated inflation expectations lately:

[Source: Cleveland Fed]

The Fed has used fear of inflation to argue against doing more for the unemployed, but what's the Fed so afraid of? Where's the evidence fo their fears?

(When fear of inflation fails as an argument against further easing, as it has, the Fed also relies upon a vague fear that further quantitative easing would somehow break overnight money markets. But as FT Alphaville has noted several times -- and I've noted this as well -- those fears are hard to understand, and the minutes from the last Fed meeting seemed to indicate they were largely unfounded.

So I, too, "remain curious to get some details about exactly what Bernanke meant when he said that further easing shouldn’t be undertaken lightly because it would pose a risk to 'market functioning' and 'financial stability.'" That's especially true in light of the statement in the the most recent FOMC minutes that they have looked at this worry and determined that, repeating a quote from FT Alphaville, there is "substantial capacity for additional purchases without disrupting market functioning."

Thus, it appears the biggest worries about further easing -- inflation and market disruption -- are unfounded, and it will be intersting to see what new excuses are invented to forestall action. I'm guessing it will be the old, "it's not in the data yet, but just wait, you'll see, inflation really will be a problem. Soon. Very soon." Never mind that we've been hearing this for years already.)

    Posted by on Saturday, August 25, 2012 at 09:19 AM in Economics, Inflation, Monetary Policy | Permalink  Comments (35)



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