Inflation is horrible, right? Yes. It destroys wealth, hoses anyone on a fixed income, and mauls the dollar and economy. But it also may be the best solution to the credit crisis, says John Makin of the American Enterprise Institute.
Makin says cuting the Fed Funds rate is only a half-measure that fails to increase the money supply to the extent required to soothe ailing credit markets. Makin believes that printing money and “reflating” the economy is the least of a number of possible policy evils:
the Fed’s intervention has done no more than buy a respite from the crisis in the financial markets. The monetary easing I’m recommending can occur by having the Fed print money to purchase mortgages directly, or purchase Treasury securities directly. The latter is probably more desirable because it adds higher-quality assets to the Fed’s balance sheet. The Bank of Japan was also forced to reflate by printing money in 2001, after two years of a zero interest-rate policy failed to lift the economy out of a prolonged recession that had moved Japan to the brink of a deflationary crisis.
Fed reflation – to slow the fall in home prices and alleviate the distress for households and lenders – carries many risks. But the alternative is to struggle with a patchwork of inadequate efforts to shore up mortgage markets, while the Fed sticks to its current tactic of pegging the fed funds rate without increasing the money supply. This, I would submit, is even more risky. It risks a severe recession that will only intensify the drive for reregulation of financial and mortgage markets after the election.
Unfortunately, Makin may be right: It’s easy to believe that Bernanke and the Fed are quietly looking to inflation to ease the debt burden of American consumers. But the comparison to Japan is a bit of a stretch. Japan actuallywas dealing with serious deflation during itse prolonged economic malaise. The United States isn’t, as yet. And living standards are being crippled by rising prices.
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