Tuesday, September 20, 2011

Paul Volcker's inflation piece in the New York Times

The great Paul A. Volcker had a must-read op-ed on inflation in the New York Times on Sept 18. He talks about the appeal of "just a little" inflation for an indebted country struggling with weakening aggregate demand. Inflation seems like just the thing to cure this malaise, right? Definitely not. And Volcker should know since he battled the high inflation of the 70s and early 80s and succeeded in breaking its back (and to the mind of many, in also setting off the great dis-inflationary asset boom of the 80s and 90s).

The thing is, once you let the inflation genie out of the bottle, it's hard to control. Fighting deflation is fun - cut rates, cut taxes, pour liquidity into the system, bump up spending, and so on. Fighting inflation requires much of the opposite - hiking rates and choking off liquidity. This is strong medicine that we have not had to take for decades. And it could seriously harm the patient.

I am extremely worried about the potential for inflation down the road because I think the Fed will have trouble sterilizing its $2T+ balance sheet. Moreover, unlike Germany that was haunted by the Weimar inflation, our greatest fear is deflation, which is why we seem so complacent about it. And given our astounding debt levels, we could not deal with even a slight deflation. We need high nominal wages and asset prices, and we need negative real yields. All this tells me, we have high inflation in our future. And probably in the next 5 years.

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