To be sure, both deficit spending and the Fed’s recent measures could, in theory, create inflationary pressure. But they haven’t, because they’ve just gone to counteract the sharp decline in consumer and business activity. The government is borrowing more, but consumers and businesses are borrowing less. As for the money the Fed has been pumping through the banks, much of it hasn’t actually made it into the economy; banks are keeping hundreds of billions of dollars in reserves on hand. If the definition of inflation is too many dollars chasing too few goods, the too many dollars aren’t out there. In the real economy, meanwhile, worker productivity is tremendously high; wage growth is stagnant; and there’s still an enormous amount of slack—capacity that’s not being used and people who don’t have jobs. All of these things will put a lid on price pressures for some time to come.
Then why are people afraid that inflation is about to get out of control? Because they’re always afraid that inflation is about to get out of control. Indeed, many of those arguing today that the Fed should place the threat of inflation front and center were saying the exact same thing last year—in the middle of a recession. To be fair, last year there actually was inflation, thanks mainly to skyrocketing commodity prices (notably, oil and food). But the core inflation rate remained relatively low, and throughout the spring and summer of 2008 the U.S. economy was losing hundreds of thousands of jobs a month, while consumers were cutting back on spending and banks on lending. Yet inflation hawks inside and outside the Fed insisted that inflation was as much a danger as recession, and called on the Fed to raise interest rates—generally not what you want to do when the economy is tanking. All this clamor had an effect: between April and October of 2008, while the recession deepened, the Fed failed to cut interest rates, and rumors about the possibility of interest-rate hikes made businesses more cautious and encouraged consumers to hunker down and hold on to their cash. And the Fed wasn’t even the worst offender in this regard—the European Central Bank raised interest rates in July, 2008, just as the world economic meltdown was beginning.
. . .
This isn’t to say that cheap money is always good—it has a nasty habit, for one thing, of starting asset bubbles. So, as Ben Bernanke, the Fed chairman, told Congress in July, once the economy starts growing again the Fed will have to start pulling money back out. But, in any balancing of the current threats to the economy, the danger of stagnation trumps the danger of inflation. Even if we are on the brink of recovery, the last thing we need is for the Fed or the federal government to start embracing a tight-money policy. To do so would risk a reprise of 1937, when, with the economy bouncing back from the depths of the Great Depression, the Fed tightened monetary policy and the government raised taxes, provoking a disastrous downturn that lasted until the Second World War. The Fed does have to make sure that the economy doesn’t go careering off the road. But let’s wait until the car is actually moving forward before we worry about applying the brakes. ♦
Originally Posted by jewels
shines.
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