As we’ve often discussed, there’s a big pissing match these days among economists about whether we’re headed for a debilitating bout of deflation or dollar-destroying hyperinflation (if there’s a happier middle ground, most folks aren’t talking about it).
On the hyper-inflation side is Arthur Laffer, who we wrote about last week, along with less polemical observers like Northern Trust’s Paul Kasriel (who is just looking for inflation, not hyperinflation). If/when the economy finally turns around, we’re in this camp, too: The Fed almost certainly won’t get the call exactly right, and we think they’ll err on the side of inflation (see the 1970s).
On the other side is Paul Krugman.
One of our economist friends likes to cite Brad DeLong’s note of caution about Paul Krugman, which is that every time your analysis leads to conclude that Paul Krugman is wrong, it’s time to revisit your analysis.
Here’s why Krugman thinks inflation is the least of our worries:
Let me add, for the 1.6 trillionth time, we are in a liquidity trap. And in such circumstances a rise in the monetary base does not lead to inflation. I had a couple of charts in my lectures this past week. First, Japan:
Next, America in the 30s:
Notice, in this case, that a Friedman-style focus on a broad monetary aggregate gives the false impression that Fed policy wasn’t very expansionary. But it was; the problem was that since banks weren’t lending out their reserves and people were keeping cash in mattresses, the Fed couldn’t expand M2. Read Krugman’s full post here >
Translation: Yes, bank reserves have gone to the moon (see Laffer’s chart in the post above; these reserves are reflected in the monetary “base” in Krugman’s charts). But this doesn’t matter, because the banks can’t find anyone to lend these reserves to. Thus, this “money” will just sit on reserve. It won’t go into circulation and drive down the value of all other money. As evidence, Krugman cites the two famous liquidity traps that, in his opinion, our current situation most resembles.