Free Markets, Free People


Our Inordinate Fear of Inflation

That’s the subject Paul Krugman addresses in his NYT Op/Ed piece today.  In fact, he implies that even talking up the possibility of inflation comes solely from bad political motives, mostly from people who don’t grasp The Fierce Moral Urgency of Change™.

Why shouldn’t we worry about inflation, according to Prof. Krugman?

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.

But, let’s grant that the current monetary moves aren’t immediately inflationary.  What happens when the economy recovers and the banks do begin to spnd those extra reserves?  Krugman attempts some sleight of hand, in an effort to make it appear that he addresses that concern.

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.

Yes, they did.  But since Japan hasn’t had a real economic recovery even today, and is entering its third “Lost Decade”, that really isn’t a compelling argument.  Since 1999, Japan’s rate of GDP growth has averaged 1.31%, which is less than half of the average GDP growth rate of 3% a mature economy should experience.  Indeed, over the last decade, Japan has experienced exactly 5 quarters where GDP growth was at 3% or more. In that same period, there have been 9 quarters when GDP contracted.  The highest annual rate of growth was in 2000, when the annual GDP growth was 2.85%.

So, let’s not pretend we know how the inflationary pressures fall out in Japan once a recovery hits…until there actually is a recovery.

ON the other hand, since our policymakers seem hell-bent on following the same path the Japanese did in the 1990s, the return of inflation when the economy recovers might turn out to be worry we can avoid until sometime in the relatively distant future.

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5 Responses to Our Inordinate Fear of Inflation

  • According to this theory, banks are sitting on ‘non-performing’ reserves, which are not generating any income. The profits of the banks should be declining, as well as interest rates. Interest rates are not declining, and I doubt that any bank CEO who wishes to retain his job would leave cash sitting around when it could be invested in something (government debt, perhaps?).

    This whole sell with the right hand, buy with the left hand thing that the gov’t. is doing confuses me. Sounds like churning to me.

  • Another thing, if I recall correctly, the Japanese gov’t. was buying bad loans, not gov’t.debt.  I don’t think that bank loans are considered to be reserves. Krugman might have a point if it were only a change in the form of reserves, treasury securities for cash, but it ain’t. Banks are not the only holders of gov’t. debt.

  • Krugman is partially correct in that right now we are still in a deflationary period, (but coming out fast) and so there is no big problem with the debt right NOW.  But in just a few months it will be. It’s a giant house of cards and in another year we will be facing bery high inflation rates.  Unless the government would all of a sudden stop all borrowing, but that won’t happen.

  • How can someone who is a certified smart guy be so fundamentally foolish?

    Krugman lived through the seventies, so he must be familiar with the economic distortion and wealth destruction wrought by The Great Inflation. Milton Friedman rose to public prominence by correctly describing our dilemma back then. Our government was incapable of dealing with,  what was for the 20th century US, a new and different problem.

    It’s not the inflation per se, it’s the threat of inflation that we are concerned about. Just as our parents and grand parents were in large part influenced by The Great Depression, those of us who lived through the worst decade of the post WWII era remember a time when a 10% raise was swallowed by higher prices and higher income taxes. Back then the income tax was not indexed for inflation, every raise you got was an automatic tax increase on devalued dollars.

    Our leaders did not have any idea how to combat inflation. The money supply went and and down like a roller coaster. Interest rates for credit cards were set and re-set with dizzying frequency. 4% 30 year bonds from solid companies like AT&T, the basis of many retirement plans and portfolios were losing value almost daily. The car you purchased in 1973 for $3000, retailed in 1976 for $5000. The value of your $40,000 home went to $60,000 in three years, but your mortgage interest rate went from 5% to 12%. Sure there were winners, but most of us were losers.

    That’s why people are concerned, because clearly the “O” administration is plunging down a path of further dollar devaluation and much higher federal spending. There’s a reason why the Germans have a healthy fear of inflation. If Krugman read any history of the 1920s, he’d understand too.

  • Krugman makes good points, but I think he neglects the real danger of stagflation given massive deficits when the country is already deeply in debt.    Deflationary pressures remain, but a lower dollar value drives up energy costs and imports, and while this ultimately leads to a rebalancing/restructuring of the world economy, it can be painful and leave us in a much worse situation.   Krugman’s argument doesn’t really deal with that possibility.