Krugman's Inlfation Scare ~ Steve Blitz Morning Notes
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Friday, May 29, 2009

Krugman's Inlfation Scare

Mr. Krugman writes in the Times today on whether all that is being done today creates an inflation problem tomorrow. Basically it comes down to two things -- how bad is the economy really (short deep recession or prolonged weak growth) and how does the Fed/Treasury handle the unwind when the recovery comes. On the first point, I think the jury is still out in the sense that in 1980 we had a similar spasm when credit controls were put in place and a quick bounce, only to be followed by a deeper recession that broadly impacted the nonfinancial sector. We probably aren't Japan in the 90s or the U.S. in the 30s but on the other hand it takes a long time for recoveries to take hold, witness the rebound post the 90-91 recession and the 2001 turndown. As to the second point, if Greenspan's Fed is any guide (no reason it should be but it is the only recent guidepost we have) the Fed will stay too easy for too long.

I think Krugman hits on the head, however, when he writes:

But does the big inflation scare make any sense? Basically, no — with one caveat I’ll get to later. And I suspect that the scare is at least partly about politics rather than economics.

First things first. It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.

So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.

The first story is just wrong. The second could be right, but isn’t.

Later he writes:

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.

The chart below underscores Mr. Krugman's point --

Last point -- is inflation only what the CPI and GDP deflators say it is?

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