I continue to think it makes more sense to fear inflation than deflation, but I cringe when I read “inflationists” who continue to over-state the case for inflation. Two recent pieces that appeared in Project Syndicate are case in point: “When Inflation Doves Cry” by Allan Meltzer and “The Ghost of Inflation Future” by Brigitte Granville.
Allan Meltzer wrote “A History of the Federal Reserve” and is considered an expert on the Federal Reserve. He wrote recently to complain about a cover story in the Wall Street Journal that declared victory for the inflation doves over the hawks. Meltzer essentially called the doves lucky. He insisted that the lack of inflation despite the Federal Reserve’s massive growth in its balance sheet was something no one on either side of the divide predicted. I actually seem to recall plenty of deflationists from 2008 to this very day who have scoffed at the notion that the Fed can do anything to stop an eventual deflationary collapse. So, I think Meltzer is too broad in trying to excuse himself for being wrong all these years about the immediate inflationary consequence of quantitative easing (for Meltzer’s dire warnings on inflation early in the crisis see his 2009 interview on EconTalk).
Even more problematic for me is that Meltzer calls on the Federal Reserve to stop paying interest on reserves, the very thing that is containing the kind of increase in the monetary supply that will surely boost inflationary pressures. Meltzer also seems to imply that the Fed should simultaneously raise interest rates and work down the reserves on the balance sheet. These two prescriptions strike me as deflationary. I suppose there is some formula whereby all these can be done in a harmony that can spur non-inflationary growth and avoid deflation, but Meltzer does not make it specific. (It is also possible that the strict limits on article length in Project Syndicate made it impossible for him to clarify).
In 2010, Mletzer wrote in the Wall Street Journal that eventually banks would start loaning out the money currently held in reserves. The only reason to do this would be if banks felt they could make more money than simply accepting the free money from the Fed. Meltzer did not say what would motivate such lending except to suggest that the Fed would get the rate on reserves wrong. Now, three years later, to advise that the Fed drop the rate altogether is to ask for a free pass to make a prophecy come true.
Mind you, I am sympathetic to the case that says the Fed will not be able to contain inflation when it finally starts up again, but the specific mechanism for a reignition of inflation is still not quite clear yet in my opinion. The Fed seems inclined to maintain an accomodative stance well into an economic recovery in order to ensure that the recovery has firm roots. That bias is certainly the seed from which inflationary pressures can (will) grow…but we need that recovery first!
Brigitte Granville wrote “Remembering Inflation” which makes the case for establishing inflation targets as a tool for maintaining the inflation-fighting credibility that central banks need to foster stable prices (see summary at Princeton University Prcess). In her piece on Project Syndicate she concludes by warning that Europe will soon go from depression to high inflation. It is a bewildering prediction given she acknowledges that the European Central Bank cannot raise its inflation target, and its program of “outright monetary transactions” must be accompanied with tight fiscal policies. In many ways, the ECB is acting as if it fears inflation more than deflation. Moreover, Granville notes that as a consequence heavily indebted nations in the eurozone will eventually be forced to restructure their debt with creditors (instead of attempting to inflate away the debt with a devalued currency). Without a devlation in the currency, I have a hard time understanding how such restructuring will trigger inflation. Instead, it is likely to make it even more difficult for borrowers in these countries to access the credit markets, sterilizing an important inflation-generating mechanism.
We inflationists have been premature and even wrong on our inflation expectations. Here on Inflation Watch, I finally acknowledged back in June that it was time to cool my inflation expectations. I still promise to maintain vigil and write related pieces, but it just does not make sense to write in such expectant tones…at least not until something fundamentally changes in the inflation picture. In the meantime, inflationists would do well to avoid predictions of inflation until they (we) can specifically describe exactly how (and when?) the inflationary threat will manifest itself. The odds for an imminent inflationary spiral are NOT 100%, probably not even 80%…