Maybe I Was Wrong on Inflation?

While the American economy is far from booming right now (think real unemployment, wage growth, inflation, asset prices, etc.) it is nonetheless as a casual observance no longer 'in the tank'. Because of both statistical and anecdotal data points, I have been thinking a lot lately about how wrong I must have been when I predicted disaster after it became clear a few years back that the continuous printing of money was just about the only arrow left in the Fed's quiver.

For those who are familiar with Paul Krugman and his theories (and terminology) I was an 'Austerian' who just didn't understand economics enough, or more sinfully, did understand it, but was applying the wrong models. Meanwhile, the Keynesian Krugman has maintained for a few years that printing money in the economic environment America was (and to some extent is) in is just fine, and that inflation would not necessarily be the natural corollary. In a little bit of a victory dance given the backdrop discussed above, Krugman published a post about those crazy people who shared my austerity viewpoint recently (not for the first time of course).

Basically, many people on the right had and have a supply-side view of the slump. This comes in different versions: there’s the view that unemployment benefits and Obamacare are reducing labor supply; there’s the Austrian view that the bubble left us with the wrong capital structure; I suspect there are other versions I’m missing. But under any supply-side interpretation, the Fed’s decision to respond by trying to pump up demand, which it has done by vastly increasing the monetary base, ought to have been inflationary.

Of course it wasn’t — which is what people from my side of the argument predicted in advance, because we recognized that collapsing demand had pushed us into a liquidity trap in which the Fed’s problem was lack of traction, not inflation.

The disappointing thing is, as I’ve already suggested, that almost nobody has been induced by this dramatic failure of prediction — or the similar error on interest rates — to change views, and possibly even concede that the Keynesians might have a point.

I am almost certain than Mr. Krugman is wrong in stating that almost nobody has changed views in light of the evidence. Specifically, I doubt he is a loyal Blawgconomics reader, as if he were he might know that I have been intellectually curious about what is (not) going on with inflation right now. And, that curiosity has led me to admit that, for now, Mr. Krugman is correct.

I would like to think (actually, perhaps that is a poor choice of words as I do not hope ill on the American economy or its participants if for no reason other than the most selfish one - maybe I should say "I would 'expect'") that some day the chickens will come to roost, and that printing a bunch of money will cause problems, inflationary and otherwise. And it cannot really be denied that there have at least been some moral hazard issues created by printing money, as well as other governmental actions like bailouts, over the past few years.

I would also like to point out that, in terms of the economic record, the past few years is, perhaps, not long enough to make a correct judgment on what the ultimate result of monetary policy actions, which are still in progress, will be. Maybe inflation has remained low because real unemployment has remained high. Maybe Chinese buying of dollars has helped to maintain a balance. Maybe we are still in the 'short run' and other 'runs' have yet to play out.

However, there is a chance, as Mr. Krugman has always maintained, that everything will be just fine. The Fed could very well engineer a soft landing and recovery, inflation could remain in check, and the American economy may get through the Great Recession (which was significantly contributed to by that same Fed, albeit under different management, in an irony of ironies) with flying colors. If this scenario plays out, if the Bernanke actions of the past few years end up being wildly successful, I will either have to come up with a bunch of excuses for how extraneous factors came into play, how the dollar's hegemony shielded it from declines, etc., or else re-think some long-held beliefs.

In any case for now, and for the record, the Krugmanites are, of course, undoubtedly correct.

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