Sunday, January 17, 2010

Inflation, What Me Worry

Economic ViewBernanke and the Beast
By N. GREGORY MANKIW
Published: January 16, 2010 http://www.nytimes.com/2010/01/17/business/economy/17view.html?

This article argues that inflation is not a danger.

It summarizes two interrelated causes of hyperinflation:
1) Inflation caused by a growth in the money supply.
2) Money supply growth caused by government fiscal problems.

The author argues that the US money supply is not growing due to government fiscal probleems but because money is being spent by goverment to prop up the economy.

The fed has doubled the monetary base over two years yet the Consumer Price Index has risen only 2% and interest rates have not risen. Further, the broad measure of money has only risen by 6% showing that banks are holding this excess cash as reserves instead of loaning it out.

If inflation does become a danger, the Fed has two tools to combat it:
1) Sell Assets such as mortgage backed securities which would soak up cash from purchasers.
2) Pay higher interest rates on bank reserves to encourage banks to hold reserves and not to lend.

The article next debates the possibility that the Fed will act too late to control inflation:
1) The fed could decide to let inflation rise to help the economy by lowering the cost of borrowing.
2) The fed could overestimate the ability for the economy to grow in light of expected tax increase to pay for the deficit and hyperstimulate the economy.
3) Politically it is hard for the Fed to increase interest rates.

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